Friday, April 18, 2014

What is a central bank?

Nick has a post on "alpha" and "beta" banks where he alights on one idea for what distinguishes a central bank from a non-central bank:
Here's the answer. Commercial banks promise to redeem their monetary liabilities for the monetary liabilities of the central bank at a fixed (or at least pre-determined) rate. Central banks do not promise to redeem their monetary liabilities for the monetary liabilities of the commercial banks. This asymmetry of redeemability is what gives central banks their power over commercial banks. But a bank with that power is nevertheless not a true central bank unless it acts like one, and uses that power.
I think this is an interesting question to ponder, but I don't come to the same conclusions that Nick does. When looking at existing central bank institutions, such as the US Federal Reserve for example, you don't see an "asymmetric redeem-ability" function like Nick postulates, and I'm sure Nick would agree that the Fed is a central bank.

So, given that central banks can and do exist without asymmetric redeem-ability, what is it precisely that they have which make them central?

Here's my take:

First and foremost, they need to act as a hub to handle payment settlements, and thus need to be able to operate at negative liquidity and capitalization levels which would put a regular bank out of business. To operate in this way they need an essentially different regulation scheme than commercial banks and are, by merit of this regulation scheme, an "extension" of the Government. There may be a better term than "extension" but I think it works for now.

In the real world this interbank interconnection is handled via reserve accounts, which are Fed liabilities and bank assets. Money circulating between banks as coordinated through the Fed so that checks do not bounce simply because of liquidity or solvency problems at a particular bank.

Another perspective is that the reserves circulating between banks via the Fed are the "inside money" counterpart to the deposits and loans circulating between the non-bank sector via the banks. The right hand and left hand sections of the balance sheets have to balance.

Note that this function is only necessary when there are multiple banks which need to have payments and transactions settle across them. If there was a single bank, in addition to the central bank, you would not need reserves to manage this process as everything would clear within the bank itself and you would not need a central clearing house capability.

Regardless, even in this scenario, you would still need/want a central bank to set interest rates. In the absence of a reserve system, it could introduce one and use requirements around that as an interest rate setting mechanism, but I think as a practical matter it would create a separate mechanism for this instead such as a modified discount window. I view the use of reserves, with their associated requirements, as a mechanism for setting interest rates as an artifact of the organic evolution of banking and not a sound, engineered solution for this function. And this then would be a second central bank characteristic, the ability and responsibility of setting rates through whatever mechanism is at hand. (And on that, note how the US Fed instigated IOR when needed--not a well engineered solution but expedient given what was on hand).

So, I do not find the story about asymmetric redeemability a compelling one given that nothing of the sort is observed in real life, and misses the key central bank function of supporting payment settlement. Instead, I would classify asymmetric redeemability as a theoretical model of something that could substitute for OMO today, but there are many such candidates and I don't think Nick was advocating this one as being particularly good.

I would also see this approach as a logical conclusion of lumping in reserves with deposits, thus conflating the liability side of the central bank along with the liability side of the commercial banking sector, and seeing those two as being fundamentally interchangeable. I think this is a source of all the errors and confusion that come from Monetarism as reserves and deposits are fundamentally different, they serve different functions, and they are not interchangeable the same way two fluids in a heat exchanger are not interchangeable nor do they intermingle. Reserves are best thought of an abstraction layer that lets independent commercial banks coordinate payments and settlements amongst depositors by having a separate reserve system act as the other part of the balance sheet at a higher level. This core function was then co-opted (again, not a great word choice) for setting interest rates.

Friday, April 04, 2014

HFT is not an act of nature

The FT reviews Michael Lewis' new book, "Flash Boys" and ends on this note:
Indeed, as Lewis explains, much of their behaviour was perfectly in line with regulations – the Securities and Exchange Commission deliberately tried to weaken the monopoly power of large exchanges to create more competition. It may not have appreciated the scale of what it would unleash – 13 public stock exchanges and more than 40 private “dark pools”.

And financial trading is not the only ecosystem that is highly complex and aggressive. “I would ask the question, ‘On the savannah, are the hyenas and the vultures the bad guys?’ ” says one of Katsuyama’s more dispassionate colleagues. “We have a boom in carcasses on the savannah. So what? It’s not their fault. The opportunity is there.”
The analogy with the jungle is telling because it presupposes that HFT, or the environment that created HFT, is simply an "act of nature" and thus being "natural" beyond this type of moral scrutiny. But markets are not "natural" -- they are constructs put together for public purpose (to use Mosler's term) and our equity markets are no different.

HFT seems so plainly on its face to be an exploit of the system, and it makes it difficult to defend it publicly, and it is this reason why I think the "only natural" argument seems to weak. The FT itself points out this contradiction because, one paragraph before declaring it "natural" it says that this came about because of changes in SEC regulation a little earlier.

The stronger arguments about liquidity and tighter spreads are more compelling, but I think Lewis makes a good case by distinguishing between liquidity and activity. Liquidity comes from players willing to take the opposite sides of trades when things are going south, not withdrawing from the market altogether, and there are few institutions capable and willing to do that at all times. I don't think HFT algorithms can be counted amongst that number either. Ultimately, I think only the government can reliable act in a truly counter-cyclical manner.

Thursday, March 27, 2014

Candy Crush IPO

Everytime a company IPOs and the shareprice pops on the first day, the press has articles about how great the company is, and there are a slew of contrarian pieces saying how pops just mean the company was underpriced and leaving money on the table, and this amounts to a kickback to unscrupulus bankers who gave their favored clients a sweetheart deal.

Well, the King IPO tanked in that it closed down 15% or so from their IPO, and I suppose this may be a contrarian piece saying the King guys are geniuses because they didn't leave any money on the table, but my real question is why the company went public at all.

The Tech Bubble, if there is one, is certainly a Bubble 2.0 as it is primarily occurring in the private market via inflated seed rounds and extremely rich acquisitions, such as the recent Facebook purchase of Oculus, and you can add Nest, Instagram, and WhatsApp to that list. King is a curious inverse, as it's the perfect company to keep private as a cash cow with a limited time horizon, but instead they go to the public markets for even more liquidity?

The entertainment business and shareholders do not mix well, and I'm thrilled to see financing vehicles like Kickstarter for projects which are worthy, but would never get funded otherwise. I would love to learn the insider story for why King decided to IPO at all.

Wednesday, March 26, 2014

Has Facebook jumped the shark by buying Oculus?

Fred Wilson asks, in his usual politic manner, whether the Facebook Oculus deal makes any sense?
If you look at these big acquisitions like Nest and Oculus, you might scratch your head. What does a Apple-style proprietary closed thermostat have in common with Google’s mobile strategy? What does a Virtual Reality headset have to do with Facebook’s social graph? Nothing in both cases.
But the roadmap has been clear for the past seven years (maybe longer). The next thing was mobile. Mobile is now the last thing. And all of these big tech companies are looking for the next thing to make sure they don’t miss it. And they will pay real money (to you and me) for a call option on the next thing.
It isn’t clear if the next thing is virtual reality, the internet of things, drones, machine learning, or something else. Larry doesn’t know. Zuck doesn’t know. I don’t know. But the race is on to figure it out.
Nest. Oculus. Google Glass. All of these are toys geeks love, and they may be the next big thing, or they might be a slightly better thermostat in a stagnant market, with no moat, a gaming peripheral, and a Segway except it's worn on the face. Time will tell.

Wednesday, March 19, 2014

Odious war debt

I think the last time the notion of "odius war debt" came up was during the Iraq War where the question was, should the newly liberated Govt of Iraq be on the hook for debt incurred by the previous regime?

Please note, the only reason this was an issue was because the debt was denominated in a currency other than the Iraqi dinar, if it had been in Iraq's sovereign currency, then it would be easy for the Govt to keep it's obligation. Also note that, as an oil exporter, Iraq is better positioned than other countries to service US$ debt.

A similar situation seems to be in play in the Ukraine. From Felix Salmon:
Now that Russia seems to have formally annexed Crimea, no one can possibly expect Ukraine to repay Russia the $3 billion it borrowed back in December. The money was given directly to kleptocratic Ukrainian president Viktor Yanukovych in order to buy his fealty; now that Yanukovych is an international pariah and Russia has seized Crimea instead, in what you might call the geopolitical equivalent of a debt-for-equity swap, Ukraine has no legitimate reason to make its payments on the loan.
But there’s a problem here: the loan was not, technically, a bilateral loan from Russia to Ukraine. Instead, it was structured as a private-sector eurobond.
My understanding of this is that Ukraine borrowed in euros on the private market in a deal where Russia supplied the euros and now holds the receivable, and it seems that this debt is senior to other Ukrainian debt.

Ukraine cannot create euros, it is a currency user not a currency issuer, and so it either needs to trade for euros to settle the debt, or renege. If it reneges, it may not end up stiffing Russia, as Russia may sell the euros to a third party.

The ECB may print the euros Ukraine needs so it can settle the debt without taking on the burden itself, but then Russia gets paid. Salmon ends:
Gelpern adds — quite rightly — that now is also the perfect time to implement a general ban on countries selling their bilateral debt into the private markets. I’m unclear on what form such a ban would take, or how it would ever be enforced, but as a principle it’s a really good idea.
I would go further. First, a country, if it can avoid it, should not issue debt in a currency it cannot issue. Second, as a generate rule, debt should be held on the books of the party that made the original credit extension, and not traded.

Friday, March 14, 2014

Bank of England goes MMT

Article from Naked Capitalism about the Bank of England confirming, as we all should know by now, that banks do not lend out deposits or reserves, and that in fact, loans create deposits. Glad to have an official source we can point to that verifies what Mosler et al have been saying for a while.

However, they don't seem to be quite ready to release the monetary lever entirely:
The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates.
There is some truth to the idea that interest rates have some impact on the amount of money created in an economy, but exactly what that impact may be at any given time is complicated and potentially context dependent as there are opposing effects -- there is a negative (fiscal) stimulus from lower interest rates, and there is a positive (credit) stimulus from lower rates. The overall impact may well depend on whether the economy is primarily being driven by weak balance sheets, and so is more fiscally sensitive, or weak cash flow, and so is more credit sensitive.

Either way, the amount of money created in a economy ultimately depends on credit decisions by the private sector, of which interest rates are but one factor, so I think the BofE places too much emphasis on their one lever (which is understandable).

More importantly, they miss out how Government spending also created money in the economy, and taxation un-creates it, thus missing out on the fiscal side of the equation entirely.

Regardless, a good first step.

Thursday, March 13, 2014

The VC Bubble

Fred Wilson says that the current sky high valuations are because of the low interest rate environment:
Since the financial crisis of 2008, policy makers in the developed world have kept interest rates at or near zero. They have flooded the market with cheap money in an attempt to heal the wounds (losses) of the financial crisis and incent business owners to invest and grow their businesses. That has not worked particularly well but it has worked a bit. Though their words have changed in recent years, their actions have not changed very much. We still are in a policy framework where money is cheap and interest rates are near zero.
If you go back and apply the formula [yield = earnings/purchase price] and use zero for yield/interest rate, then one would pay an infinite amount for an earning stream. Of course that doesn’t make sense and it has not happened. But valuations are at extreme levels because you cannot get a decent return on your money doing anything else.
Fred is correct on the logic of both valuation calculations and what the Fed may think they are trying to do, but I don't think I agree and I don't think Fred's own data supports his argument.

He has a graph of Treasury yields which show a steady decline from the 80s to present day. Note that the internet bubble of the late 90s happened in a higher yeild environment, so I don't find the argument persuasive that valuations are increasing since the denominator in a DCF calculation is getting smaller. And let's face it, the big VC exits that give rise to bubble talk are not for companies generating much cash, or in industries that seem to have many moats.

I would also argue that there is a big difference between credit bubbles and asset bubbles, and the VC industry, being primarily asset funded, is insensitive to interest rates.

I do believe a story where historically, VC returns have been too high because that market was small and inefficiency. As more capital discovers it, it will drive returns down by funding more marginal companies. This additional supply could fuel an asset bubble if immature acquirers are willing to overpay in some high profile ways while they remain glamor stocks (in the case of Facebook) or have an excellent moat (in the case of Google). Note that the more seasoned companies -- Apple, Amazon -- do not make big acquisitions.

As VC as an asset class gets normalized, there may be a private market bubble as expectations readjust. But ultimately, I think the new equilibrium will have more companies, and more marginal companies, being funded which is good for us all.

Friday, February 28, 2014

Flexible Exchange Rates, MMT, and the Ruble Crises of MMT

Ramanan continues on his MMT critique focusing on Forex. sovereignty, and flexible exchange rates. The standard MMT position around "currency sovereignty" is simply that a state has the ability to issue its own currency and thus is "sovereign" in it's matter. State obligations, in its own currency, are easily extinguished by it issuing more, and moreover, were initially funded by it issueng currency.

A simple thought experiment: if I was to establish winterspeak-land tomorrow, no one could pay a tax denominated in winterspeak-bucks because none would exist, nor could anyone buy a winterspeak-bond because they would have no winterspeak-bucks to do so with. The original winterspeak-buck would need to come from somewhere, and that somewhere would be me (else it would be counterfeit).

This is in some ways the most intuitive part of MMT, and yet it seems to cause problems when you have higher level discussions on more technical points. Regardless, let's turn to the real world and see just what the limits are to currency sovereignity, what the real world policy space is re: floating exchange rates, and what a countries' Forex obligations actually are.

First, let's establish that any goods and services that a state can generate and provider for itself can be entirely managed in its own currency. However, most states need some imports, and those imports may or may not be available in the state's own currency. In those cases, the state will need to either export real goods and services to get the required currency, or will need to be able to swap it's currency for the target currency on a forex market.

In the currency swap scenario, the state can either let the currency float freely, or it can attach it to some sort of peg. If the currency floats freely, then currency sovereignty it maintained. If there's a peg, then sovereignty is compromised as the state will be obligated to maintain that peg, or default.

In practice, most countries operate on what I called a "mixed currency regime" where the citizens use a mix of local and foreign currencies. This is certainly true in third world countries, and this mixed regime reflects how sovereignty in those countries is also weak -- there is usually limited law enforcement, corruption, weak property rights, etc. As the sovereignty of the state increases, you find mixed currency regimes becoming less mixed, and if the state is hyper-sovereign, ie. has the ability to dictate, or at least strongly influence the affairs of other states, then you find its currency beginning to dominate in those other countries as well. The US$ is exhibit A.

Ramanan writes:
Now, it is clear from the above quote that Mitchell admits that nations with government have a constraint on fiscal policy. But the more troublesome fact is that he presents it as if the government doing this had some full volition to not have been indebted in foreign currency.
It depends on how much the country wants to import. Free trade has costs instead of benefits, and a country can easily develop internal auto industries, for exmaple, if it wants to. The cars won't be as good as if they came from Japan, but it could do it. Aside from certain commodities, countries do have the option to trade less, and this become less indebted in a foreign currency, although that also has costs.

He continues:
So the Neochartalist story that somehow the government shouldn’t borrow in foreign currencies is vacuous. Only a few nations have the ability to attract investors to purchase their debt in domestic currency and typically these nations are successful in international trade. But this by no means guarantees continued success – if net indebtedness to foreigners keeps rising relative to output because trade in international markets for goods and services turns weak, then output gives in. And a shift in investors’ portfolio preferences also can lead to the original sin, even if one starts with zero government debt in foreign currency.
I don't agree that the MMT story is vacuous, I think it highlights another real cost and risk to free trade. He ends on what I consider another non-sequitor:
Now the backfire effect: in the “modern monetary theory” blogs, examples such as those of Pakistan are presented as if it was Pakistan’s policy makers huge error to have borrowed in foreign currency and to their fans this appears to strengthen the view that in the supposed world which the Neochartalists fantasize, there is no balance-of-payments constraint. And the error is the failure to recognize that “money” has an international aspect in addition to what it has to do with the government and banks.
At present, the solution is for the world leaders to provide a coordinated fiscal expansion and induce the creditor nations to increase domestic demand and hence increase latter’s level of imports. But the long term solution is to move away from a system of free trade. And that is far from the “MMT” overkill description of the world and overly simplified solutions.
I'm very familiar with Pakistan, and borrowing in dollars with a peg certainly constrains Pakistan's ability to use fiscal policy to boost domestic demand if that's what necessary. Honestly though, Pakistan's bigger problem is it's inability to generate savings demand for rupees from it's domestic population because it has very weak tax collection. Stronger tax collection would mean a bigger sink for rupees, reducing inflationary pressure, and letting it run higher deficits. Pakistan's need to borrow in foreign currency stems directly from it being unable to tax in it's own, although I do not want to imply that if it could tax in rupees that would fund it's ability to spend in rupees. The mechanism isn't a causal funding mechanism. The Pakistani government is a limited sovereign.

The ruble example of 98 is interesting because there, Russia defaulted on ruble denominated debt, which it could theoretically have honored. The contagion mechanism there was actually first world hedge funds, who were forced to sell other positions because their foreign debt portfolios were being squeezed.

One of the more interesting MMT insights, as stated by Mosler, is "exports are a cost, imports are a benefit", which is the opposite of the usual narrative where export driven economies, like Japan, are hailed while import driven economies, like the US, are said to be more vulnerable. When you look at straight goods and consumption, it's obvious that a country wants goods (which are hard to produce) more than it wants it's own currency (which is trivial, the trick is in getting it accepted). There are other reasons why an import heavy economy generates it's own costs, but if you had to choose between beads or the island of Manhattan, I hope the choice is clear even if you aren't conversant in MMT.

Wednesday, February 26, 2014

The future of news

Marc Andreessen has a post on the future on news, and it's interesting to see how his experience has colored his views (as happens to us all). Some interesting elements:
The news business is a business like any business. It can and should be analyzed and run like a business. Thinking of news as a business is not only NOT bad for quality, objective journalism, but is PRO quality, objective journalism. A healthy business is the foundation for being able to build high quality products, and to do so sustainably. That includes journalism.
The main change is that news businesses from 1946-2005 were mostly monopolies and oligopolies. Now they aren’t. The monopoly/oligopoly structure of newspapers, magazines, and broadcast TV news pre-‘05 meant restricted choice and overly high prices. In other words, the key to the old businesses was control of distribution, way more than anyone ever wanted to admit. That’s wonderful while it lasts, but wrenching when that control goes away.

The news "business" was split into two parts -- tabloid journalism (or the old "yellow press") who dealt with sensationalist headlines, and the "serious" press who felt more responsibility, for good or will, of the individuals they were trying to influence. Within both of these, there was the business side, focused on advertising and classifieds, and the content itself which was run quite separately. The Church and State divide should illustrate how newspapers were never really, or at least not entirely, in the business of selling information for money. Nor is it clear that there is any market at all for the traditional, high minded, "serious press". Maybe the NYTimes should be run as a non-profit where they can ditch all the ads and focus on telling us what to think.

Some other titbits:
Right now everyone is obsessed with slumping prices, but ultimately, the most important dynamic is No. 3 – increasing volume. Here’s why: Market size equals destiny. The big opportunity for the news industry in the next five to 10 years is to increase its market size 100x AND drop prices 10X. Become larger and much more important in the process.
"Market size equals destiny" is a great sound bite, and I see how Marc's experience with Netscape, as the web exploded, and now as a VC who listens to pitches all day, would shape this idea. There is also a great deal of truth to it.
An obvious one is the bloated cost structure left over from the news industry’s monopoly/oligopoly days. Nobody promised every news outfit a shiny headquarters tower, big expense accounts, and lots of secretaries!

Unions and pensions are another holdover. Both were useful once, but now impose a structural rigidity in a rapidly changing environment. They make it hard to respond to a changing financial environment and to nimbler competition. The better model for incentivizing employees is sharing equity in the company.
Again, really? I don't think Unions and pensions were about motivating employees, I think they were about giving labor more bargaining power vis a vis management so labor could get more profits for themselves. And while Marc's had great luck with equity, I'm sure he knows from his VC position how that just isn't true for the median employee across his portfolio companies.

I'm not arguing for either unions or pensions here. Both have serious problems. However, in this current climate where Silicon Valley billionaires are being criticized for being out of touch, "let them eat equity" may not be the most appropriate thing to say.

Friday, February 21, 2014

Facebook lost the social graph

Various companies have tried to build out identity systems on the web, and none of them were successful until Facebook came along with it's social graph. It did this by offering a service where real world identity was key to it working (as LinkedIn did before) but then crucially, offering that as a platform via FBConnect (which Linkedin did not do, and maybe it could not have given it's more narrow focus).

But on phones, such social graphs already exist and they are called your address book.
With new consumer Internet companies being started every day — and online consumers notoriously fickle — a next big thing will always be rising up to threaten Facebook’s dominance. As a result, Facebook, like other technology companies, is left playing an expensive game of Whac-a-Mole, scrambling to buy its newest competitors and keep those users out of the hands of its rivals.
“This exposes the strategic fallacy behind Facebook, which was the idea that there was going to be a monopoly on the social graph, and that Facebook was going to own it,” said Keith Rabois, a partner at venture capital firm Khosla Ventures. “That’s not true, and I don’t believe Facebook will constantly be able to buy its way out of this structural challenge.”
Whatsapp does not have a social graph, it leverages the social graph in every address book. And it was only successful because of how operators chose to charge for text messaging instead of offering it for free, or as a more reasonably priced option. The inability of telecoms to profit off mobile is remarkable.

update: Albert Wenger agrees and thinks that Facebook overpaid for WhatsApp:
Having had some time to think about that I am now convinced that this deal makes no sense.
Why? Because phone number based messenger apps can bootstrap very rapidly off the graph that is contained in people’s address books. We are witnessing that now with the Telegram Messenger app which apparently signed up nearly 5 million users yesterday. The UIs of all of these apps are virtually identical and are also extremely similar to the basic SMS UI that everyone around the world knows and understands. The combination means there is virtually no enduser lock in at the messaging layer.
I wonder to what degree this was motivated by Mark's own history? His experience has consisted entirely of "make something kids use to connect with each other and become wealthy". Facebook gained traction right away and has not had to deal with any real failure. It's also not how people connect on their phone.

Wednesday, February 19, 2014

Palley on MMT

Ramanan is very impressed by Palley's MMT critique (pdf) and while I think there are good MMT critiques out there, I don't think Palley's is one. I also think, crucially, he missed why MMT has (what little) appeal that it does.

Palley is correct, though, in pointing out that a failure to phrase things in terms of DGSE means that the theory has not made headway in the academy. I know JKH hates the term "paradigm", but it was used by Kuhn in a particular way for a particular reason which is applicable here, and Palley lays it out very clearly in his introduction:
This question can only be answered by placing that power within a theoretical model and exploring its implications. For the last seventy years the language of macroeconomics has been small scale simultaneous equation models with dynamic adjustment mechanisms attached to explore issues of stability. Proponents of MMT have a professional obligation to provide such a model to help understand and assess the logic and originality of their claims.
I am not opposed to models at all, as I've stated repeatedly on this blog, but I also know that if you start with radically different assumptions you're not going to make progress and MMT attacks orthodox macro at the assumption level. Moreover, models are built within pre-existing interpretations, you do not write out a bunch of equations and then do what they say, and when you're changing the interpretation, beginning with equations may not help.

Before diving into the Palley paper more deeply, let me also say that the only reason MMT currently has it's current moment is because orthodox macro has failed. It's been failing in Japan for 30 years, but now that we have the same situation in the US, and we have the internet and write in English, the failure has become pretty clear. Palley is right in asking MMT to explain price stability and full employment, provide a credible theory of inflation, and justify monetary policy and it's effects; but frankly I think all of those questions can be turned on textbook macro as fairly, and with greater urgency since they are the ones in the drivers seat. Because right now there's a big gap between what's between the book jacket and what's outside the window.

Palley spends some time talking about how it is common knowledge that "sovereign issuers of money are not constrained financially in the normal sense". Great. And yet we hear continual talk about the US Govt running out of money. So it may be common knowledge for Palley, but it is not common knowledge more broadly, and if MMT is working to popularize that understanding he should be applauding it not yawning. A little support towards the common good, please.

Oddly, Palley makes no distinction between the US situation, where the deficit is in US$, and the EU situation where member country deficits are in euros. So there seems to be a real difference between the Palley view and the MMT view on this.

Like Palley, I am stunned by the claim that MMT rejects counter-cyclical fiscal policy. Certainly contrary to what I've heard, and if Wray really does take this position then we'd have to disagree. There's a longer post I keep meaning to write about "employment" where I want to talk about this further. However, I don't agree that MMT has no theory of inflation, nor do I think there is a single "theory of inflation" as the observed behavior can have different causes. The Phillips curve has, at times, not accorded with reality.

If I'm to engage with the model Palley sketched out (thanks!) it would be to point out several areas where his sketch conflicts with MMT.

1) Palley asserts that the deficit (D) be zero in a static economy, thus requiring T - G = D = 0. However, in MMT aggregate demand is conditional on the need for what I'll call "savings" for now to be met, "savings" defined as G-T. And this demand may be non-zero. It is, in fact, the very variability of this which Palley does not model, and so misses the core MMT contribution.

2) Palley also sets up a condition where Gmin cannot exceed Tmax. Again, in MMT, why? Certainly if the policy interest rate is set to zero, any difference between Gmin and Tmax can be made up by the consolidated fiscal and monetary authority (which Palley supports earlier) borrowing from itself, or running in overdraft conditions, depending on how you want to think about it.

3) And finally, I would ask that Palley himself puts forward a theory of inflation in his model beyond the footnote where he says "to avoid inflation the high-powered money stock must grow at the rate of growth". Why? What exactly is the automatic transmission mechanism between high-powered money (a stock) and inflation (necessarily a flow phenomenon)? There is no automatic mechanism, on a volitional one (spending) and it is here that MMT adds something beyond standard Keynesianism.

Finally, I too have concerns with ELR, but I don't believe they are part of MMT, merely a policy recommendation, and my concerns are different from Palley's, who attacks it from the Left.

To come: flexible exchange rates where I give first hand testimony from the great ruble crises of '98

Friday, February 07, 2014

Bitcoin Mania

A surprisingly cogent article from Fortune, of all places, on Bitcoin:
Bitcoin's primary significance is not about whether it supplants cash. It's about a revolutionary computer-science breakthrough that has the potential to upend all sorts of established industries.
It's rare that a pure technology comes along, with so much power, but so little obvious application.

Monday, January 27, 2014

Corporate profits helped by weak employment

Weak aggregate demand has two impacts on business, one negative and one positive. The negative impacts is on the top line with weak sales leading to weak revenue growth. The positive impact is on OPEX, with a weak labor market helping to hold costs in line. So, an economy with enough demand to hold up revenue, but still weak enough to keep labor markets in check, might be great for corporate profit. Without end-customer demand to justify hiring ramps or capex outlays though, that profit would just pile up as cash.
The strength (in profits) is directly related to the weakness in hourly wages, which are still growing at just a 2% nominal pace. The weakness of wages and the resulting strength of profits are telling signs that the US labor market is still far from full employment.
The article ends on a somewhat corporate bashing note, I don't think it's reasonable to critisize corporations for trying to maximize profits, but I do agree that aggregate demand is the biggest economic issue in the US today.

Wednesday, January 22, 2014

Who are the 1%?

Krugman makes an observation that I've made several times on this blog -- there are too many people in the 1%:
White-collar professionals, even if married to each other, are only doing O.K. The big winners are a much smaller group. The Occupy movement popularized the concept of the “1 percent,” which is a good shorthand for the rising elite, but if anything includes too many people: most of the gains of the top 1 percent have in fact gone to an even tinier elite, the top 0.1 percent.
And who are these lucky few? Mainly they’re executives of some kind, especially, although not only, in finance. You can argue about whether these people deserve to be paid so well, but one thing is clear: They didn’t get where they are simply by being prudent, clean and sober.
Krugman is certainly part of the 1%, but maybe not the 0.1%, and he does not see himself as a malefactor of great wealth. A married, mid-career professional couple will find themselves making over $250,000, comfortable by any standard and likely in the 1% or close, but such a "prudent clean and sober" couple is not driving inequality in the US. That's being driven by the Finance industry, which is growing primarily on debt and derivatives. The latter can be outlawed, and the former can be more accurately priced by banning securitization and forcing sound credit management by requiring debt to be held on the issuer's books to maturity. Manage resulting credit contraction through fiscal action.

Friday, January 17, 2014

Recessions and Ethical Norms

Tim Hartford has a nice piece outlining the basic understanding amongst economists for Recessions. He gives it a behavioral spin by including the very human reaction against price gouging. To wit:
There are obvious microeconomic consequences of this pigheaded insistence on the appearance of fairness: ticket touts, empty supermarket shelves in unseasonal weather and restaurants at which one cannot get a seat.
But what is less obvious is that the course of recessions and booms might also be shaped by our desire for prices that move in line with accepted ethical norms rather than the laws of supply and demand.
If prices adjusted swiftly and smoothly, “Say’s Law” would always hold true. The gnomic law, named after a Napoleonic-era French economist, is that “supply creates its own demand”. The implication is that recessions can only be due to supply shocks, not simple lack of demand, as Keynesians claim. Prices and wages should adjust to ensure that supply and demand are always equal. In the world of Say’s Law, monetary policy should have little or no effect. Quantitative easing would be of scarcely more significance than a new set of commemorative postage stamps.
Yet prices and wages sometimes fail to adjust. Occasionally this is for psychological reasons; at other times the hassle of changing the price tags, reprinting the menus and so on can delay price adjustments... Of such inflexibilities are born substantial economic fluctuations – the intellectual descendants of John Maynard Keynes often look to price rigidities to explain why recessions happen at all.
The riddle of a recession is why the market -- usually for labor in the case of unemployment -- fails to clear. If someone cannot get a job for $100/hr, why not accept one for $80/hr instead of being unemployed and collecting $0/hr?

I've promised a longer post on unemployment, which is still to come, and I think that understanding unemployment is important in understanding economic booms and busts. However, I do think that Hartford should look at Keynes' own work on debt driven deflation and perhaps talk to some households and businesses, ideally with nominally fixed mortgages, about why they don't simply work for less. Economic models wash out debt because "for every borrower there must be a lender and so, at the economy level, it balances out". But the fixed, nominal price of outstanding debt is the rigidity which keeps prices and wages failing to adjust.

Taking Hartford's argument at face value though, price gouging is usually triggered by higher prices, not lower. In a recession, the required price adjustments would be downwards. So I don't know if the irrational reaction to gouging is helpful in understanding this observation.

Wednesday, January 15, 2014

Barbarous Relic 2.0

Fred Wilson lays out the path he sees for Bitcoin:

1) Bitcoin emerges, community develops, mining, wallets 2) Bitcoin vice, silk road, etc
3) Speculation, trading, collecting, price spike
4) Commerce - real people buying real stuff with Bitcoin 5) Bitcoin as infrastructure
I think there will be a step 3.5 where Bitcoin will crash in value as a the speculative phase comes to its predictable end and the Feds start to wrap some regulation around it. This means there will be no step 4.

That does not mean that Bitcoin as infrastructure may not come about though. The irony, if I may use that term, with bitcoin is that it uses a lot of software to re-create the metallic nature of money and create a sort of digital gold standard (or barbarous relic 2.0 if you prefer). But money is not so much a medium of exchange nor a store of value, as economists argue, but a means to tallying and tracking indebtedness or obligations.

As outlined in Graeber's Debt, and is also clear upon a few moments reflection, indebtedness, the asking for and returning of favors, long predated money which merely abstracted and made portable that fundamental owed/owing dynamic. I still owe, but whether I owe my bank or a different bank or a bond holder depends on a secondary market that is independent of me. When a Government declares I owe them taxes, and those taxes must be denominated in a specific currency, it is a fulcrum that the entire economy will then turn on.

By losing focus on the tally, which is the important part, and focusing on the token, Bitcoin has developed an interesting and powerful technology for a use which is besides the point. Like Fred, I am eager to see what use it finds next.

Tuesday, December 24, 2013

Merry Christmas!

Best wishes to all winterspeak readers : )

Friday, December 20, 2013


How did I only just learn this was finally happening?

Wednesday, December 18, 2013

The underconsumption theory and unemployment

I strongly recommend the comment thread in this interfluidity post where Mark Sadowski does a good job clarifying the difference between wealth and income, and what the data says in terms of distribution and consumption in the context of an underconsumption theory of unemployment.
In underconsumption theory recessions and stagnation arise due to inadequate consumer demand relative to the production of new goods and services. Consequently it is precisely the income that is derived from the production of new goods and services that is connected to the matter of whether underconsumption is actually taking place. The income derived from the buying and selling of assets is completely peripheral given the very nature of underconsumption theory.
“About your IRS example, if you do not want to pay taxes all at once as a result of selling the asset outright, you can borrow to pay the lump sum tax payment and spread the payments out over time, just as you would have a time series of tax obligations by renting out the property.”
I never mentioned “taxes”. The only reason why I brought up “IRS income” is because that is the only context where capital gains are even referred to as “income”. Capital gains only relate to the buying and selling of assets and hence are not income in the conventional sense of that which is derived from the production of new goods and services. My point in making the comparison was that referring to capital gains as income will produce a measure of savings that is wildly inflated compared to the more normal measure of savings out of the income derived from the production of new goods and services, which is of course the measure of savings relevant in this context.
“Moreover, I hope that this can be internalized as a truism: no one receives NIPA income.”
Frankly, this is bordering on the ridiculous. Nearly everyone receives NIPA income, and given that the income derived from the production of new goods and services is the measure of income that is relevant to underconsumption theory, that is the measure of income that I think we obviously should try and stay focused on.
I think SRW's interpretation of inequality and growth has certain causal chains backward, but propensity to consume is an important factor to consider when thinking about what impact distribution may have on demand. If, when looking at income and not capital gains (as Mark convincingly argues), high income earners spend as much as lower income earners, then that's good empirical data to have. That said, I also think there is a budget constraint/wealth effect, but that may paradoxically have more of an impact on low wealth households. In this sense, what drives demand is not inequality per se, but the sensitivity of low wealth households to spend out of income as a function of their wealth -- including capital gains.

I'll need to read the original paper to see if this effect is there, as the comments are focused on the upper end where there turns out to be little to see.

Friday, December 13, 2013

Chris Dixon is not being Ironic

As the micro-genre of Silicon Valley bashing/critique continues to grow, Chris Dixon writes this, I assume entirely unironic, PR piece about a recent investment:
One of the interesting things about Bitcoin is the contrast between how it is portrayed in the press and how it is understood by technologists. The press tends to portray Bitcoin as either a speculative bubble or a scheme for supporting criminal activity. In Silicon Valley, by contrast, Bitcoin is generally viewed as a profound technological breakthrough.
The presupposition is that speculative bubbles, criminality enhancement, and technological breakthroughs are in some way mutually exclusive. Morozov may be tedious at times, but his talking about the Manichaeistic worldview with permeates new technology is right on.

Bitcoin is an interesting technical solution but it solves the wrong problem because it conceives of money as commodity, instead of a formal accounting system for obligations. Regardless, the distributed cryptography that it's built on is quite amazing, and perhaps someone will build a useful application on top of it instead of Bitcoin, which is primarily a bubble and a facilitator of criminal activity.