We’ve written from time to time that not all debt is created equal. Prudent business borrowing enables companies to make investments and expand operations. And even though governments like the US that issue their own currency may nevertheless sell bonds, operationally they can simply create more dough to fund spending. The constraint on spending is creating too much inflation, not bankruptcy. And since as we’ve regularly discussed, the business sector chronically underinvests, deficit spending is necessary and desirable most of the time. Economist Mariana Mazzucato has argued that there are certain risks, such as engaging in basic research, where the uncertainty is too great for entrepreneurs. And that’s before getting to the fact that the party that makes the discovery could easily see its technology exploited by free riders.
However, economic studies have regularly found that high levels of household debt is a negative for economic growth. Moreover, some economists have found a strong relationship between high levels of consumer debt and economic crises. Yet if you read the business press, analysts and government officials see rising consumer borrowing as a plus for growth. How does that make sense?
A recent Bank of International Settlements paper (hat tip UserFriendly) helps reconcile this apparent paradox. The immediate impact of household borrowing does indeed spur the economy near-term but creates drag down the road. And the level at which household borrowing becomes a net negative is 60% of GDP, when nearly all advanced economies are at higher levels. Worse, the dampening effect is more pronounced when the household debt to GDP level exceeds 80% The BIS puts the US as above that threshold….Naked Capitalism
Bank of International Settlements Paper Confirms That High Levels of Household Debt Hurt Growth
Yves Smith
27 comments:
The fastest way to fix everything would be for us all to stop paying for it. No more mortgage, interest, credit card or insurance payments.
If one person stops the system strips them to the bone. If 150 million people stop the system is finished.
United we stand, divided we fall.
Tom, you're doing a me....
I dont see the connection to reserve operations wrt USTs... and what Yves writes here...
Also here:
"The constraint on spending is creating too much inflation, not bankruptcy."
This is antithetical to "its about price not quantity" ...
There is NO functional relationship between the QUANTITY of spending and the PRICE...
Where some in MMT say "the constraint on govt spending is inflation" that is bull shit...
There is NO functional relationship between aggregate spending and the price of things...
Prices are determined by a different process than aggregate spending...
MMT needs to figure this out...
If one day you went to buy a gallon of gas and it is $2 and then a year later it is $4 ONLY in ex post analysis can you determine that twice as much was spent on a gallon of gas...
iow yes you could say that "we spent twice as much on gas!" but the cause of the price increase of 2x is not that you spent 2x... the 2x is ex post accounting not causal...
Matt, cost-push inflation puts pressure on the supply side (commodities, price of oil, etc). That pressure generates the change in price--such as what happened from 1973-1980 when the oil embargo drove prices up 10X ($3 to $30/barrel), and affected everything from the cost of food and transportation, getting to work, and whatever that automatic contractual thing that was in union contracts then that automatically forced wages to follow some inflation index (why companies got the idea to outsource or move off-shore under Reagan). It doesn’t take a brain surgeon to figure out what the consequence of cost-pull inflation of critical commodities is going to do to a society (not to mention the hoarding and price-fixing that hedge funders are allowed to get away with with valuable national resources).
The last time we had demand-pull inflation when there too many dollars chasing too few goods was at the end of WWII. Marriner Eccles and the boys were really worried what would happen after the war—they saw the end of it coming—when all the stateside workers with their bulging savings accounts had nothing to spend it on, and commercial durable goods were scarce because of rationing for war material. This is well-documented in the Congressional Record; I actually read the shit.
So they slapped a draconian tax on the very rich, allowed the workers to keep more of their money subsequently creating the middle class, and used the $15 billion Marshall Plan to fill US factories with $15 billion of orders for Germany, France, and Italy to rebuild themselves that gave the millions of returning soldiers (and the stateside war workers) a job.
"I dont see the connection to reserve operations wrt USTs". Then, you need to read Frank Newman's book.
Prices are determined by a different process than aggregate spending...
Yes and no, is one of the factors, but is not necessary and sufficient cause.
People really really don't understand causality. Should understand this at the bare minimum: https://en.wikipedia.org/wiki/Necessity_and_sufficiency
TYom being a philosopher has this internalized probably, but 99.99% doesn't.
Even demand-pull and cost-push inflation are constructs with partial explanatory power, although is better than dumping it all under the same flag.
Inflation is hard to explain because is at core at why we have and need a market based economy to set prices. If we could formulate a "theory of inflation" properly we wouldn't need markets at all.
Given that prices transfer across the supply chain and at every steep there are different actors which play a role in setting price is hard to causally explain what is creating price increases, also generalization at aggregate levels is opinionated on things like consumption baskets and applied subjective coefficients and usually ignores other factors.
It's just a lazy way for us to talk about aggregate shortages or excess supply, which makes it not very useful as a policy tool, instead of focusing on particular prices of particular sectors and goods.
Is the BIS saying anything we didn't already know? If someone gets a bank loan and spends the money that's stimulatory. When they pay it back, the effect is the opposite, i.e. deflationary.
Next the BIS will tell us water is wet and grass is green.
why we have and need a market based economy to set price. That's only part of it. The federal government is the main price setter. It has the means to change any price, something the market cannot do with the govt power and thoroughness because it can’t create dollars. [A recent anecdotal example of this is Trump reducing the cost of planes.]
But then we’ve had no congressional fiscal wisdom for the three decades, and zero understanding of how sectoral balances work, and how you grow economic sectors.
You might want to reread this, which Tom highlighted at the time. “Escape Fandango,” by Paul McCulley. Although if English isn’t first language, you might miss some of it.
Here on MNE:http://mikenormaneconomics.blogspot.com/2014/09/paul-mcculley-escape-fandango.html
The PDF: http://media.pimco.com/Documents/PIMCO_MacroPerspectives_McCulley_September2014_GBL.pdf
And just to give Matt a bad case of agità, there’s this: lol
The deficit is too small, not too big
BY PAUL MCCULLEY, CONTRIBUTOR - 10/24/1, THE HILL
http://thehill.com/blogs/pundits-blog/economy-budget/302464-why-are-we-afraid-of-deficits-austerity-is-only-helping-the
It’s a good article.
Ah the BIS is finally acknowledging that UK professor Colin Crouch's "privatized Keynesianism" doesn't in the end cut the mustard (do the trick)!
It has the means to change any price, something the market cannot do with the govt power and thoroughness because it can’t create dollars.
Yes, but only upwards (so yes, in case of "inflation"). Government is a buyer, so it increases demand and can set prices higher competing for the supply at current levels. The government can act to effectively put price floors.
The government doesn't work in isolation though, it can outbid the private sector (and in some cases it does), but it does not bid (in practice) in all and every market, and there are also political constraints to what and where it can bid.
Although the government is a huge factor in price setting, is not the only one, and is not a sufficient cause for inflation (but is a NECESSARY one as it's the creator of the currency and hence has unlimited bid power in normal circumstances in our current system). Causality is hard to get because how prices move around the supply chain and the interaction between excess supply/demand of good and increases/decreases of income in the different sectors of the economy.
"Matt, cost-push inflation puts pressure on the supply"
MRW you've got at least 2 figures of speech going on here...
"inflation" is itself a figure of speech... as is "money!"...
If you read the Fed Res Act, it says "maximum employment with stable prices.." which I think is better...
The whole concept of "inflation!" is just another vestige in gold era theory that is still being applied today by the unqualified economists...
MRW,
He is saying we should save more... doesnt make any sense at all...
We could have a great economy with a very small deficit... the late 90s we had surpluses and things were going pretty well...
Warren says "its always an unspent income story..." so then McCulley says we should increase our rate of savings?????
He doesnt get it... not qualified...
Now he is out there putting on his new corn pone Colonel Sanders act which I guess is appealing to some...
Matt, he said the opposite in what I read: "Unless faced with an incipient inflation threat, born of an overheated economy, there is no reason whatsoever that the public sector should ever have a positive savings rate.
What it should have is a positive, a bigly positive, investment rate."
”the late 90s we had surpluses and things were going pretty well…”
Matt, going pretty well? The public sector had the surplus. The private sector had the deficit. The people--the 70% (households)--were leveraged up the ying-yang. It caught up to them in 2008 when the dam cracked.
People really really don't understand causality. Should understand this at the bare minimum: https://en.wikipedia.org/wiki/Necessity_and_sufficiency
Tom being a philosopher has this internalized probably, but 99.99% doesn't.
Right. Causality has been one of the knottiest problems in explanation and justification since people started trying to formulate and explain it rigorously. Causation in social science is more difficult to account for than in the physical and life sciences where transmission is more evident, that are fewer confounding factors to deal with, and theory can be tested experimentally.
Wikipedia has a good summary.
See also Stanford Encyclopedia of Philosophy for a more in-depth treatment.
causal determinism — see determinism: causal
causation:
backward (Jan Faye)
causal processes (Phil Dowe)
counterfactual theories of (Peter Menzies)
in Arabic and Islamic thought (Kara Richardson)
in the law (Antony Honoré)
and manipulability (James Woodward)
medieval theories of (Graham White)
mental — see mental causation
the metaphysics of (Jonathan Schaffer)
probabilistic (Christopher Hitchcock)
I agree, Matt. I was being too tough on Yves and so I took that criticism down.
What I was referring to was, "And even though governments like the US that issue their own currency may nevertheless sell bonds, operationally they can simply create more dough to fund spending."
This makes it seem that bond issuance is part of a fiscal operation, whereas it is purely monetary since there is no change to the amount of aggregate non-government net financial assets that we call $NFA for short here at MNE when a government issues a security. Amount of $NFA remains the same and only the term changes.
On the government's consolidated books it is just shifting the same liability from one type of account (demand) to another type of account (time), like shifting a deposit entry in a checking account at a commercial bank to a savings account or CD to get more interest.
We all know that and I assume that Yves does too, but on my reading the way she stated it looks like bond issuance is part of fiscal operations.
We all know that and I assume that Yves does too, but on my reading the way she stated it looks like bond issuance is part of fiscal operations. But it is still a reserve operation because of that gold standard-era law that says US Treasury General Account at the Fed can't have an overdraft after the Fed pays the vendors on US Treasury/Congress spending instructions. Can never remember the year Fullwiler cited. 1917? 1928? 1932? What's the expression? "Reserve add before reserve drain?"
Blah blah blah.
The system doesn't work for the majority, how do we fix it? Some smart people here, maybe time to start thinking outside of the box?
Just 2 clarifications:
This makes it seem that bond issuance is part of a fiscal operation
It does not: fiscal operations involve taxing and spending, they never involve bond issuance.
From the government's consolidated books it is just shifting the same liability from one type of account (demand) to another type of account (time)
Until the Treasury issues the bond the only consolidated government sector liability were the central bank reserves that will be exchanged for the bond. Now that consolidated government sector owes a bond held by the private sector. But comparing this bond (that may fluctuate in market value) to a time deposit doesn't seem to be a very good analogy, IMO.
But comparing this bond (that may fluctuate in market value) to a time deposit doesn't seem to be a very good analogy, IMO.
Yes, the analogy breaks down on that score, but all analogies break down at some point.
I think it is a valid analogy, albeit with qualifications. The banking operations are pretty much the same between the cb and commercial banks that people are familiar with. An existing liability is simply moved from one type of account to another with no change in the amount.
Is there is a better one?
In my experience the analogy seems confusing for lay people - and even accountants and financial analysts- when they read about it in MMT texts.
A reserve deposit at the Fed does look like a demand depoisit in a bank - but a government Bond (or a company bond for that matter) just doesn't "seem" like a deposit in a bank at all.
Perhaps something like "savings certificates" would be a better analogy?
How about stating it this way:
When the Treasury issues a bond the effect for the private sector is the following: a demand deposit at the Fed is changed for a savings certificate at the Treasury?
I don't believe that there are any certificates issued anymore. It's all electronic. A person orders a tsy and a deposit account is debited and a securities acct credited at the bank but shifting bank liabilities. The bank orders up a tsy and purchases it for the customer which creates a debit in the bank's account at the cb and a credit in the bank's securities account at the cb. This mirror the operations at the bank wrt to the customer purchasing the tsy. The difference is that with shifting a deposit to time account at the bank just stays in the bank's books. In the purchase of a tsy the government's books are involved. It seems to me to be pretty obvious by thinking in terms of crediting and debiting accounts on different books — the customer's, the banks's and the government's. In the case of the person buying the tsy, the bank just acts as the broker since the customer purchasing the tsy doesn't have access to the CB.
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I don't think that when a bank (a primary dealer) buys a Treasury security at a primary auction there is "a credit in the bank's securities account at the cb"
What happens in acccounting terms is likely the following:
Bank: minus asset (reserves at the Fed), plus asset (Treasury security).
Fed: minus liability (bank reserves marked down), plus liability (Treasury account at the Fed is marked up)
Treasury: plus asset (account at Fed marked up), plus liability (bond, note or bill).
Right.
This all occurs on the Fed's spreadsheet with the Treasury having an account there, The cb being the government's bank.
Cb's generally don't issue securities, only the currency. Tsys are Treasury liabilities. Consolidating cb and Treasury, these are functionally government liabilities. The account have different titles.
The Treasury is said to "spend." But that is not actually the case. The legislature appropriates a budget distributed across agencies that spend iaw direction. The invoices go to Treasury and Treasury directs the cb to credit the appropriate accounts. That's how government spends.
Cb's generally don't issue securities, only the currency.
Well, not in the case of American currency. Only the Bureau of Printing and Engraving under the US Treasury actually issues the currency. The Federal Reserve handles/manages the order.
When I discussed this with a director of the Bureau of Printing and Engraving in TX in charge of these operations—one of the currency-creating sites nationwide—she said what actually happens is that when a bank in WA state, say, orders up $X of USD dollars, the bank contacts its regional Federal Reserve.
[I’m doing this from three-year-old memory because I’m not willing to look through my email.]
There is a Federal Reserve Agent in charge of handling these currency requests at each regional Federal Reserve bank that a requesting bank deals with. The bank must provide 100% of the collateral that $X represents. The requesting bank has to check in with this Agent at the end of every business day to verify that the collateral is still in place. This is statutory law.
The Agent orders the $X in currency requested from the Bureau of Printing and Engraving site, who prints it up, and delivers it. Can’t remember whether they deliver to the regional Federal Reserve, for onward forwarding, or if the cash is delivered to the bank directly.
Currency has two meanings, cash and government liabilities.
Cash is currency as taken or money-thing.
Most cash is in the form of bills and US bills are Federal Reserve notes.
Government liabilities are the money (in contrast to the money-thing) denominated in the government's unit of account.
When A bank orders currency for its vault cash, it exchanges bank reserves (settlement balances) for it at the cb.
When cash is eliminated (coming soon to a country near you), currency will only be issued digitally. Eventually, it will likely be blockchain since this looks to be the most efficient system.
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