An economics, investment, trading and policy blog with a focus on Modern Monetary Theory (MMT). We seek the truth, avoid the mainstream and are virulently anti-neoliberalism.
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Wednesday, March 30, 2011
Winning the, "How are we going to pay it back?" argument
If you're an adherent of MMT like me, then you've probably gotten into arguments about debt and deficits with members of your family or maybe your friends or colleagues from work and I'm sure at some point in those discussions you've been asked the question, "How are we going to pay it back?" when it comes to government debt.
I have come up with a way to answer this question, which will at the very least, make the person you are arguing with sit up and think.
Here's a hypothetical conversation that you are having with a typical debt monger:
Debt monger: How are we going to pay it back?
You: The government exchanges dollars for those Treasuries. Holders of the debt give back their Treasuries to the gov't in exchange for dollars and Voila! no more debt.
Debt monger: You mean "print money" to pay off the debt?
You: That's precisely what I mean!
Debt monger: Are you serious?? That will create hyperinflation!
You: No it won't.
Debt monger: What?? Are you crazy??
You: Not at all. You are taking away one form of money--the Treasury--and simply replacing it with another form--US dollars.
Debt monger: But Treasuries are not money!
You: Oh really? If I had $10 million in cash and you had $10 million in Treasuries, would you consider yourself poorer than me?
Debt monger: (Confused look, but you can tell he's thinking.)
You: I rest my case.
Try it next time you're at a party.
Another simple answer is that debt is paid back as it comes due, and US Treasury debt is coming due all the time. It doesn't come due all at once. When a tsy matures, the government just credits a bank account and voids the tsy, while marking down its securities account and marking up its currency account on its books.
ReplyDeleteIt's like what happens at your bank when a CD comes due. The bank cancels your CD account and credits your deposit account in the amount.
What happened? The amount of funds remained the same but the asset from changed from a time deposit to a demand deposit. Same thing happens when a tsy matures and is exchanged for cash plus interest. It's similar to making change.
What people don't get is that they are revenue constrained so they have to obtain the funds to pay down debt. Being the currency issuer, government doesn't.
Isn't that inflationary? No. The amount of net financial assets held by nongovernment remains the same, only the composition and maturity change.
Oh really? If I had $10 million in cash and you had $10 million in Treasuries, would you consider yourself poorer than me?
ReplyDeleteWouldn't this depend on the rate of inflation? Treasuries bear interest and have maturity dates and sometimes coupon payments. So whether I felt richer or poorer would depend on the term and interest payment schedule of the treasury, as well as what I expect inflation to do - or not do - to my dollars. No?
On the question of paying back the debt, it seems to me that answering the friend's fundamental question in a reasonable way doesn't depend on the particular contributions of MMT in any essential way. Isn't the point just that even if a government finances its deficits purely through taxes and borrowing, governments can run continuous deficits, and service the accumulating debt through economic growth? With a given average rate of GDP growth and stable tax policies, a government could have a deficit every year, a debt that grows every year in such a way that the debt/GDP ratio never changes, and tax revenues that increase every year such that the overall tax rate never changes, and the over rate of debt service to GDP never changes. The debt keeps growing along with GDP and never gets paid back.
It seems to me that what this hypothetical friend or family member needs to understand better is just basic accounting arithmetic, not MMT.
MMT just adds another wrinkle to the debate by pointing out that even if a sequence of permanent deficits turns out not to be sustainable through borrowing and taxation alone, the sovereign issuer of currency has various options, such as spending more currency into the economy to increase output, or paying off government debt by crediting bank accounts. And so long as we are not at full employment, this is a viable option.
"Isn't the point just that even if a government finances its deficits purely through taxes and borrowing,..."
ReplyDeleteThe MMT point is that a government running a fiat currency cannot fund itself with taxes or finance itself with debt because that is a nonsense statement for a currency issuer in a fiat system. A government can act as if it is taxing to fund itself or borrowing to finance itself, and may even believe this, but that does not make it so. This is a key point of MMT. Miss this and miss MMT.
Excluding transaction costs, at that point in time, there is no difference between $10 million in treasuries or cash.
ReplyDeleteDan,
ReplyDeleteYes, but it's a technicality, semantics. Would you feel that you were sitting there, shaking, hoping that you would get "paid back" from the gov't?
For me, one of the best questions to baffle debt-mongers is, "where do people get their dollars to buy US debt?"
ReplyDeleteTry to walk them down the line and show them that all dollars are spent into existence by the federal govt. This helps illustrate the "fiat" nature of currency and debunks the notion of an external restraint.
If they want to be a smartass and say "banks," ask them, if that was the case why did they need to be bailed out? That should also baffle them and at least get them to admit that they don't know much of what theyre talking about.
Joe,
ReplyDeleteI agree. Very effective. I've used it.
Dan,
ReplyDeleteSaw your inflation concerns over at billyblog.
If you'd like check out this video that Bill Mitchell is in at the 15:45 minute point of the part 2 video at the link below, he and Warren Mosler talk about the concept of "inflation" in a modern monetary environment. "Inflation" is not so simple a concept to understand. (for me anyway!)
Link_http://bilbo.economicoutlook.net/blog/?p=12089#more-12089
Resp,
Joe, this is my favorite, too.
ReplyDeleteYou: The government exchanges dollars for those Treasuries. Holders of the debt give back their Treasuries to the gov't in exchange for dollars and Voila! no more debt.
ReplyDeleteDebt monger: At which price?
You:... (confused look, but he can tell you are thinking)
From the Treasury Direct Website: "When a bond that has reached final maturity is converted, TreasuryDirect will ***automatically*** redeem it and purchase a Zero-Percent Certificate of Indebtedness (C of I) in your primary account." "The Zero-Percent Certificate of Indebtedness (Zero-Percent C of I or simply, C of I) is a Treasury security that does not earn any interest. It is intended to be used as a source of funds for purchasing eligible interest-bearing securities"
ReplyDeleteYou may transfer the 0% C of I's to a bank or use the funds purchase more securities.
Thanks Matt,
ReplyDeleteJust to be clear: It's not so much that I have inflation concerns, myself. It's more that in a political environment in which the deficit terrorists have advanced their cause by stoking tremendous fear of inflation and hyperinflation, I would appreciate it if the MMT theory of the causes of inflation weren't buried so much in the background - at least in blog discussions. I am trying to arm myself with a strong battery of arguments, and learn all the twists and turns so I can defend my pro-deficit spending position against every kind of charge raised against it.
What I find is that many of the MMT defenders are fixated on operational matters, and refuting the claims about potential government insolvency. But when I have discussed MMT ideas with friends, they mostly quickly get to the point where they say, "Yeah, yeah, I get the point about the government being operationally incapable of insolvency ... but that's because they can always fulfill their bond liabilities with worthless depreciated dollars that they have overspent into existence!"
I know the subtitle of Randall Wray's book is "The Key to Full Employment and Price Stability." I have ordered the book but haven't received it yet. So thanks for the Bill Mitchell link!
My goal in all this is to improve my ability to persuade people off of the quack austerity program that is in the process of wrecking the UK's economy, and is about to be implemented in the US by the deficit maniacs who have taken over here.
Quick question...
ReplyDeleteEven if dollars and Treasuries are both forms of money, doesn't the difference between them in terms of liquidity have relevance for inflation? Even if one follows the more simplistic definition of inflation (too much money chasing too many goods), one doesn't 'chase goods' with Treasury Securities the way one might with dollars, correct? And I realize that increasing the money supply won't be inflationary if it leads to an increase in the production of goods and services - I'm on board with that - but just in response to posted scenario, isn't it the case that financial assets in the form of Treasuries have different 'inflationary potential' than financial assets in the form of dollars, or am I missing something?
mbjstl, according to MMT experts like Prof. Scott Fullwiler, who has answered this elsewhere recently, no difference.
ReplyDeleteTomatoBasil, the C of I is essentially crediting an account with reserves, which can be used to roll over a tsy, or else create a bank deposit. Most likely that a maturing tsy will be rolled over, unless there is a better use for the funds.
ReplyDeleteDan Kervick, as I said, "inflation" is an ambiguous terms and most people don't have a clue of what they are talking about when the use it. Ask, what do you mean by inflation. The usually cite rising prices and their wages staying the same. That's not inflation. It's a relative price rise. Inflation is a continuous general price rise, including the price of labor. All the prices stay about equal only everything goes up. This is an advantage for debtors since debts are easier to pay down with depreciated money, and it disadvantages creditors because the payments on principal and interest they receive are worth less in real terms.
ReplyDeletembjstl: you are right. if the fed buys your 1000$ bond for 2000$ or 5000$ it doesn't matter according to MMT. it's just replacing one net financial asset with another. go figure...
ReplyDeleteDan, you can debunk austerity even without MMT. Just show them a chart of the US output gap and the deficit (as a % of GDP). The mere fact that the former leads the latter so reliably, and over such a long period oftime, should at least make people think about their position.
ReplyDeleteMammoth,
ReplyDeleteWhat's your point? All we're saying here is that a bond and a dollar bill are the same thing, so there is no "debt" per se.
If you're saying that there has been a nominal increase in the quantity of money while the economy had been at full employment and output, then yes, that could cause inflation. MMT agrees with that. We've been all through that recently. But you're taking huge leaps and presuming things that you shouldn't.
Mike, all I am saying is that a dollar bill and a bond are similar but not the same, especially long term bonds.
ReplyDeleteWhen someone buys a bond from someone else in the open market, then yes, there is no change in NFA.
When the Fed buys a bond from someone then there is a change in the composition of NFA, which depends on the price at which the Fed is buying the bonds.
Is the same mistake as saying that QE is the same as if the Fed had not issued debt in the past. It depends. If the fed pays 500$ or 2000$ for my 1000$ bond it makes a big difference that it issued the debt in the first place.
Mamoth:
ReplyDeleteDebt monger: At which price?
You:... PAR, when it is redeemed.
According to the latest US Treasury statement here:
Link_https://www.fms.treas.gov/fmsweb/viewDTSFiles?dir=w&fname=11032900.pdf
Look on the right column of page 1 and you see:
Public Debt Cash Redemp. (Table III-B): 3,486,940 ($ million)
So YTD the Treasury has "bought back" almost $3.5T of "debt" so far. There is only about $9.5T total out in the public. Some may have been net "rolled over" but you get the point. The Treasury is "paying back" the "debt" every day/week/month/year.
If you dont like current prices then just hold your bonds to maturity, overwhelming majority will roll off in just a few years as most USTs are short term.
Consider that as an investment, bonds should always be bought as if your intention is to hold to maturity, otherwise you are trading them.
Resp,
Mamtho's examples imply "concern" if the price of treasuries were higher than par (i.e. the $2000 or $5000 price of a $1000 bond.) If that were the case, wouldn't that mean the "opposite", of what debt critics warn, was happening. In other words, we would be in deflation and/or rates would be dropping tremendously if bonds were double or five fold higher than par and in that case we would want to increase aggregate demand wouldn't we?
ReplyDeleteCrake:
ReplyDeletePrecisely. What Mammoth describes is incongruous with any scenario that would support a sustained and rising inflation.
I have no concern, just pointing out why money and bonds are different things. Money has constant nominal value, bonds do not, as Matt reckoned.
ReplyDeleteThere is a difference between a horizontal and a vertical swap of assets, I am surprised MMT people don't make the difference.
Buying and selling bonds at the horizontal level leaves NFAs unchanged, as if nothing had happened.
That is not the case at the vertical level. Saying that bonds and reserves are a liability of the government and an asset of the private sector so swapping one with the other does not make any difference is nonsense.
Mike, speaking of straw men, I didn't mention inflation in any of my previous comments.
ReplyDeleteMamoth,
ReplyDelete"so swapping one with the other does not make any difference is nonsense"
Do you mean in terms of when you do the swap?
I always assume it would be swapped out at redemption.... otherwise you are trading them by definition.
Resp,
Matt, you are right. I am thinking of the MMT description of QE as an asset swap (although it is actually a trade).
ReplyDeleteMy point is, I repeat, money and bonds are not the same. Pretty similar, but not the same. In the case of a horizontal trade (or swap) it doesn't matter. But in the case of a vertical one, it does.
Whenever we are engaged in deficit, debt disputes with concerned people, we should always start our argument with this:
ReplyDelete"Although US government doesn't need any loans from anybody as it creates money in thin air by simply spending it and makes it disappear in thin air by taxing it,........"
Mosler makes a case that selling or redeeming treasuries is just an accounting act versus money creation:
ReplyDelete"When the Treasury’s are sold or redeemed, the reserves that were “stored” at interest are simply switched back, creating a deposit again. It’s pretty much the same as buying and redeeming a CD. It’s just a switch from demand to time back to demand in a bank account, and a switch between reserves and securities at the government level. That is to say, the government doesn’t have to draw on revenue, borrow, or sell assets to cover its “debt,” as households and firms do. It’s just a matter of crediting and debiting accounts on the (consolidated) government books, even though it may appear that there is a financial relationship occurring between the CB and Treasury due to the accounting. However, it’s just a fiction."
http://pragcap.com/the-concept-of-vertical-and-horizontal-money-creation
Interesting post. I am new to the concept of treasuries as I recently started investing with an online broker and there are different avenues for investment that I would like to learn more about. I can tell that this topic of conversation would be controversial on a party...so I might bring it up when I am more well versed on the topic ;) thanks for sharing
ReplyDeleteCrake, interest paid by the govt is a NFA creation.
ReplyDeleteWhat Warren says shows that there is no solvency problem and that the govt can always redeem its debt. That's right.
That does not mean bonds and money are the same.
It's a way of convincing someone and there are others. What usually happens is that the person you are explaining this to seems to understand. At least he is letting It go. But he will continue tomorrow with the same line like he is brain dead or something
ReplyDeleteThat's what frustrates the hell out of me.
I have no concern, just pointing out why money and bonds are different things. Money has constant nominal value, bonds do not, as Matt reckoned.
ReplyDeleteRight, but that is deceiving in a floating rate system, where the value of the currency is also volatile, not only bonds. Bonds move in tandem with the value of the currency due to arbitrage.
For currency and bonds being interchangeable, go here and search for "Scott Fullwiler."
ReplyDeleteBTW, there is a spirited conversation over at Interfluidity here, with many penetrating comments.
Thanks for the links Tom. I will check them.
ReplyDeleteBut I think I didn't make myself clear enough.
* money has constant nominal value (not constant real value)
* bonds and money are interchageable of course, that's why people trade them.
* so are dollars and euros, and apples and oranges, but they are not the same
MamMoTh, currency and bonds are obviously not "the same" or we wouldn't be having this conversation. They are both govt. liabilities, but currency is zero maturity and tsy s are non-zero maturity. That means that they cannot be the same in the sense of identical. What makes them the same in the sense of equivalent is that both correspond to the same amount of NFA at face value and par. As you note, bonds can and do vary from par. Currency remains nominally the same, although its value fluctuates in the fx market.
ReplyDeleteHowever, what Scott is saying (I think) is something a bit different. Even though one can't buy anything with a bond, as one can with cash, it is still "money in the pocket" in the sense that currency is because tsys are exchangeable (virtually instantly).
So there is no functional difference between holding currency and holding a bond wrt spending power. Holding currency doesn't increase the desire and ability to spend over holding a bond, so no bonds is not inflationary. Scott goes into this more deeply. I have just attempted to summarize the gist of his ideas (and I may not have put it exactly).
MamMoth: Bonds and money are the same thing, or two types of the same thing, which can change into each other. The dollar bill in your wallet has a date on it, in the past. A bond is just a dollar bill with a future date on it. To know whether something is a bond or a dollar, one has to know two things, the current date & the date on the bond/dollar/money/debt. Bonds become dollars when they mature. Conversely, if you invented a time machine and went back 10 years, the 2011 dollar bill would become a bond.
ReplyDeleteMike: The right way to think of it is not that bonds are not debt, but that dollars are debt too, just like bonds.
No Calgacus, they are not the same. You can exchange dollars and euros, but they are not the same. You can exchange apples and oranges, but they are not the same.
ReplyDeleteAlthough you can sell your bonds to obtain dollars, you can only spend dollars.
So if you have 2 billion in dollar deposits, you can spend up to 2 billions at any time.
If you have 1 billion in dollar deposits and 1 billion in bonds, you can only spend up to 1 billion at any time.
Of course they are not identical - nothing is. The dollar in my pocket is not the same as the dollar in yours. But the only economically significant difference between a bond and a dollar bill is the date printed on it. The treasury, Fed and bond traders could play their finance games with printed dollar bills with different dates and nothing at all would change.
ReplyDeleteYou could perfectly well spend bonds, especially if you had a billion dollars worth - a rational recipient would prefer a billion in bonds to a billion in currency. A 2012 maturity bond has a constant nominal value in terms of 2012 dollars, while 2011 dollars trade a bit above par in terms of 2012 dollars, just as foreign currencies, which are equally money, have changing exchange rates, but constant value in terms of themselves. A dollar is nothing but a matured bond.
Mike’s proposed argument with a hypothetical debt monger above is great. As he says, at least it makes debt mongers “sit up and think”. I’ve had pretty much this conversation with several people.
ReplyDeleteNevertheless, turning Tsys into cash wholesale WOULD BE stimulatory and possibly inflationary, and for the following reasons.
Warren Mosler makes the obvious point in his “Soft Currency Economics” essay that the higher are interest rates, the more the private sector will save. (He actually says this in the course of his “parent, child and business card” analogy.
Conversely, reduce the interest earning opportunities for cash, and the private sector will try to dissave cash, the effect of which is stimulatory. And the effect is significant. This source says the interest elasticity of savings is around 0.7.
http://www.eurojournals.com/IRJFE%203%204%20peter.pdf
But that’s not an insuperable problem. To pay off the entire national debt, just start buying back Tsys with newly created money. And to the extent that that is excessively stimulatory, mix the latter stimulatory debt reduction method with a deflationary debt reduction method: raise taxes and use the money to buy back debt
A bond is a "post-dated dollar"?
ReplyDeleteCalgacus, would you be will to pay 1 million dollars for 1 million dollars in 0 coupon bonds with 200 years maturity?
ReplyDeleteCrake, interest paid by the govt is a NFA creation.
ReplyDeleteWhat Warren says shows that there is no solvency problem and that the govt can always redeem its debt. That's right.
That does not mean bonds and money are the same.
I think Warren, Mike, and co consider government bonds to be part of NFA. However, in your straw-man scenario where the FED over-pays for a bond, its the same thing as deficit spending all things being equal, by the amount over overpayment.
It's even got a name. It's called "the fiscal channel of monetary policy."
ReplyDeletebubbleRefuge, how did the Fed try to bring down interest rates with QE without "overpaying" bonds?
ReplyDeleteHow much will you pay for a 200yr million dollar bond with no coupon?
Mamo,
ReplyDeleteThe policy idea would be to only issue short term USTs.
Matt, I thought the idea was to stop issuing debt altogether. The US is already issuing mostly short-term bonds isn't it?
ReplyDeleteIn any case that wasn't my question which has to do with the difference between money and bonds, regardless of which country issues both.
A bond is a "post-dated dollar"? Yes.
ReplyDeleteCalgacus, would you be will to pay 1 million dollars for 1 million dollars in 0 coupon bonds with 200 years maturity? Of course not. But depending on how many the government printed, I might be willing to pay say $1000 for it. One can think of bonds as just a different denomination of cash. Alternatively, illiquid cash - say a million pound note, is much like a bond. Have you ever tried to get change for a million in a one-horse town on a Sunday? You'ld be happy to get 999,900 ones for it.
The point is that dollars are debt, just like bonds, which are a more general concept. Dollars, any form of money incorporate futurity into themselves already. If you knew when you would die, the rational plan is to die broke. The ultimate source of value of a dollar bill, the reason why people trade them for real assets, is their use toward future tax payments, exactly like bonds.
My point is not really about the denomination of the bond or the bank note. The 200yr million dollar bonds can be issued in 100 dollar bonds if you prefer. The only difference being the maturity date.
ReplyDeleteI even wouldn't use bank notes in any argument. Bank notes are a relic of the past which we could pretty much dispose of if we wanted to right now.
I rest my case that MMT is not consistent when describing QE as an asset swap. There is no such thing as a vertical asset swap, or debiting 1000$ from every deposit account and then crediting 2000$ (that is, running a budget deficit) should also be just an asset swap.
Debt monger: But Treasuries are not money!
ReplyDeleteYou: Oh really? If I had $10 million in cash and you had $10 million in Treasuries, would you consider yourself poorer than me?
Debt monger: No, and I would not consider myself poorer either if I had $10 million of GE bonds or $10 million worth of green beans. You can trade anything for anything, what's your point again?