Sunday, October 16, 2011

Rogue Economist — Net Financial Assets


The rogue economist provides a long and detailed exposition of the meaning of "net financial assets" based on my previous comments there.

"Net financial assets" is a key MMT concept, so it is definitely a worthwhile read. I'm bookmarking it, too, in order to refer others to it. It meets a lot of objections and corrects erroneous ideas now being bandied about.

Read the post at Rogue Economist Rants, What is net financial asset

Here is my comment there:

Thanks for providing a detailed explanation of net financial assets.

I must clarity that the term "net financial assets" is not my term. It is a key term of Modern Monetary Theory (MMT).

MMT emphasizes the distinction between vertical, "outside," or exogenous money creation by the government as currency issuer, and horizontal, "inside," or endogenous money creation by bank lending.

When banks lend, loans create deposits, which are withdrawn and spent into the economy. Loans are booked as bank assets and deposits as bank liabilities. The net is zero. No net financial assets are created when banks lend. What is created, however, is an interest obligation that exceeds the value of the loan, which must be repaid in addition to the principle.

Conversely, when government deficit spends it creates financial assets in the private sector. These financial assets have no liability in the private sector, so they are non-government net financial assets. The net financial assets injected by government come with no interest payable by the recipient.

This is the basis of the vertical-horizontal distinction that MMT draws, and it is why the government as household analogy is erroneous. Households, firms, and states in the US are currency users, while the federal government is the currency issuer. Missing this distinction is the reason for a lot of junk economics.

A government that is the monopoly provider of a non-convertible floating rate currency is not operationally constrained because it funds itself with currency issuance. Such a government does not tax to fund itself and it does not borrow to finance itself. A currency issuer does not need to get money elsewhere. It issues it.

Taxes withdraw net financial assets previously injected by deficit expenditure. Governments withdraw some of the NFA through taxation for two reasons. First, taxes create a need for the government's money, which Warren Mosler calls a tax credit. This gives value to otherwise worthless pieces of paper. Secondly, governments withdraw NFA from non-government to regulate inflation.

Government does not usually withdraw the total net financial assets it injects. Historically, the US government has generally run a deficit. Only once was the national debt paid down.

The residual of deficit spending is the "national debt." It should be obvious from the above that the "national debt" is actually savings of NFA held by non-government, accruing interest that is also created by currency issuance and adds NFA. All the brouhaha is complaining about growing national wealth in the hands of non-government. Does that complaining make sense?

IN the MMT macro view and policy recommendations based on it, fiscal policy — injection and withdrawal of non-government NFA — is used to adjust nominal aggregate demand to nominal aggregate supply at full employment with a view toward achieving full employment and price stability. In this regard, MMT holds that fiscal policy based on "functional finance" is superior to monetary policy, since it can be adjusted to changing non-government desire to save in order to ensure that the balances of the sectors — government, domestic private, and external — sum to zero at full employment.

7 comments:

GLH said...

Mr. Hickey:
If I understand correctly, MMT claims that it makes no difference where the money from a government budget deficit goes, either to rich or poor. If I am wrong please correct me. But, when the government creates the treasuries to match its spending, then does that money not basically disappear back into oblivion? If that is the case, then if the government budget deficit is not channeled to the consumers instead of debt investors, then it seems the only benefit to the economy from a budget deficit would be from the interest from the debt.
In my mind it somehow seems that, in our present system, the government spending creates a wash since taking money out of the system by creating debt just nullifies the money put into the system by spending, which would only benefit the rich. Please explain.

Matt Franko said...

GLH,

One other point first. There is the external balance. In August the US Current Account Deficit (Trade Deficit) was $45B. The Fiscal Deficit for the month of August was say 100B +/- so the foreign entities that sold us $45B more than we sold them, are saving almost half of all the USD NFAs created in the month of August. By our trade policies, we are allowing foreign entitites to save USD NFAs... (almost half of all created)

This takes us to the idea of SAVING and SAVINGS DESIRES.

MMT 'would say' imo it DOES matter to an extent 'where' the deficit (ie NFAs) go. To increase output (and hence employment/income) the NFAs are best directed to US domestic entities (households and businesses) that have a greater propensity to SPEND them here in the domestic economy instead of SAVE them. These would be the households at the bottom of the income scales imo.

That's why Warren Mosler's quick proposal is to eliminate FICA, increase SS payments, give every US person a $5k annual healthcare debit card... etc..

Most of the MMT proposals drive the creation of NFAs to the entities most likely to spend them at this point (which is not the 'top end of town')...

Resp,

STF said...

Hi GLH,

"If I understand correctly, MMT claims that it makes no difference where the money from a government budget deficit goes, either to rich or poor. If I am wrong please correct me."

Yes, that is completely wrong. It makes a ton of difference--as Randy Wray once wrote, how many bombs do you have to build before you create 1 job in Harlem?

"But, when the government creates the treasuries to match its spending, then does that money not basically disappear back into oblivion? If that is the case, then if the government budget deficit is not channeled to the consumers instead of debt investors, then it seems the only benefit to the economy from a budget deficit would be from the interest from the debt."

Don't confuse the deficit spending with the bond issuance. The spending is going to whomever the govt is spending on--as above, it matters a lot who/where/why. But the bond sale does not drain that spending. The spending is an increase in income; the bond sale is an exchange by an investor of deposits for a liquid bond (and often not even that, as bonds purchased by primary dealers are usually financed by the latter's borrowing via repo).

Think of it this way. Is there a difference between receiving a $10,000 check in the mail from the govt and having $10,000 of your retirement portfolio converted to deposits? The former is an increase in income as occurs when a deficit is incurred; the latter is an asset swap like a bond sale (actually, like a bond purchase by the govt, but same thing in reverse because I wanted both transactions creating deposits to make the point). It would be completely irrational to look at these two as the same thing, and have your decisions about spending be exactly the same. As such, these cannot be a "wash."

Further, the investor purchasing a bond isn't better off. Absent the Treasury bond purchase, he/she could have invested in a CD of the same maturity, which would have roughly the same interest and also be backed by the govt (via FDIC, in this case). Yes, there is a difference to the economy as a whole in terms of interest payment from govt to investor, whereas bank paying interest to investor is a "wash" in the pvt sector. But that's a separate issue, and at any rate the recipient of the spending also received income.

Hope that helps.

Best,
Scott Fullwiler

Matt Franko said...

GLH for instance the 2011 FY deficit was 1.3T.

that is about 110B/mo.

but almost HALF of that is going to foreign SAVERS. So "our" deficit is really only about 700B, and these 700B NFAs that remain in the possession of US entities are mostly going to corporations who use them as "retained earnings" (ie corporate SAVINGS) and high end households, perhaps IRA/401k, etc.. who dont need/desire to spend them.

If you look at this report from the BEA:

http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_3rd.pdf

Table 11, BEA is tracking net undistributed US corporate profits at guess what? $709B for this year.

So you can see from this data, that households are net saving NOTHING, and Foreigners and US Corporations are getting ALL of the NFAs at this point....

So the idea here would be from this point, increase the creation of NFAs thru tax cuts/job guaranty, but from the "bottom" up... until we see increases in US domestic employment and output...

Resp,

GLH said...

First, thanks to both STF and Matt Franko.
I'll start with STF first. What you say sounds more logical since the benefits of the government deficit are going to people who will spend it. By the way, do you know the name of Randy Wray's article so I can search for it?
Now, Mr. Franco, thanks for pointing out the leakage from the budget deficit to the current account deficit. I think you got to what I was really trying to ask about the economy. If I understand you correctly, the government budget deficit just barely covers the leakage to current accounts and corporate savings which are probabley going back into Treasuries. If that is the case, where is any growth in the US coming from? I wouldn't think it would be from exports. What is your idea?

Matt Franko said...

GLH,

The so-called 'growth' is coming from a reduction in the m relative to x in the (x-m) term in the GDP equation. Due to the fact that demand for certain imports and their prices may have fallen more than US exports. (x-m) is 'less negative' than last year.

Y = C + I + (X - M)+ G

This is how they believe we have "growth" ie 'we imported less'. Tom has put up some posts here about how we measure "growth", and I think Bill Mitchell has opined about these orthodox ways of measuring economic "growth"... seeking/suggesting alternatives.

Resp,

beowulf said...

"high end households, perhaps IRA/401k, etc.. who dont need/desire to spend them."

I read the other day that tax-deferred retirement plans (both defined benefit and defined contributions) are a $142 billion a year tax expenditure.
http://www.americanprogress.org/issues/2011/01/te_011911.html

Average tax rate for account holders is somewhere between 20% and 25%, so this implies $568B to $710B (3.8% to 4.7% of GDP) in long-term savings that are a demand leakage that nobody pays attention to. Add to that a trade deficit of roughly the same size, there's your budget deficit. Housing was one hell of a bubble for it keep going for years in the face of that headwind.

The solution is to take them both off budget. Trade deficit via an import certificate market; as for retirement savings... I'd put federal public investments, (coincidentally, about the same size, $600B this year) off budget annually up to the sum of retirement savings... Or we can pray for another bubble
:o)