Guest post by David Gerlitz.
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There's been a lot of discussion going around recently about the Central Bank ripping up the portion of National Debt they hold, thereby reducing the amount of debt of Governments. (See here, here, here and here).
Some of the arguments suggest this would be inflationary, even possibly hyper-inflationary. But consider the accounting in such a scenario (using the US as the example): The Fed is not allowed to buy bonds directly from the Treasury. They buy the bonds from the private sector in exchange for reserves. As is well known by now, this is purely an asset swap. Far from being inflationary, it could be considered deflationary by reducing the amount of interest Treasury pays on the bonds to the private sector. By paying the interest to the Fed instead, and then having the Fed turn around and send it back to the Treasury, the repo (or QE) essentially performs the act of tearing up the bonds already. Further, the 'restraining effect,' or 'crowding out' of bonds on private expenditure is largely a myth. Given that Treasuries can be leveraged just as easily as cash, what's lacking in the private sector isn't cash to make investments, but rather profitable investments to risk that capital on. Now consider what happens if you take the extra step and actually destroy the bonds. Now you've got an accounting problem because you destroyed an asset without destroying the liability. One approach then is to simply leave those reserves in the system and have a mismatch between cumulative deficits and debt outstanding. This would maybe be Wray's or Lerner's approach. But let's say you wanted to keep the accounting clean: Assuming you're not going to take back 1.6T from the Treasury (which would defeat the purpose) and you're not going to take back those dollar reserves from the private sector (again, deflationary and absurd), then the only place left to take the liability is from central bank capital. What are the liabilities of the central bank? 1. The reserves they create and 2. The equity they issue. In the US, the Fed is "owned" 100% by the banks. If you wrote that equity value down, then you have to write the value of it down from the banks balance sheets as well. The fact we've gotten this far should show how absurd this line of reasoning is and that it's never going to happen anyway. But ultimately the result is not inflationary. So reducing the debt outstanding in this way isn't helpful because repo's and Quantitative Easing perform the task already. They're exactly equivalent to "ripping up the debt." It doesn't increase the deficit or create wealth for the private sector. Now, Beowulf makes the point that policy makers may feel better with less outstanding debt--if you can get past the accounting issues--and thereby lead to more fiscal spending. But again, I'm not sure that's the case. Reducing the cumulative total of outstanding debt isn't going to change the minds of those who have an ideological bent against government spending, debts or deficits. They'll fight the spending just as hard. But that's exactly what's needed--what's always been needed: better counter-cyclical fiscal spending designed around jobs and increasing private sector incomes, not accounting gimmickry. |
It is very likely that the government’s total debt is now peaking thanks to sustained QE. This means the total amount of dollars in the hands of the private sector will be shrinking and any additional spending cuts or tax increases will only hasten that shrinkage.
This could end up being a challenge for the economy, but it also could be super bullish for the dollar because it will create shortages of dollars. It’s exactly what happened in Japan and one of the reasons why the yen is so strong.
By paying the interest to the Fed instead, and then having the Fed turn around and send it back to the Treasury, the repo (or QE) essentially performs the act of tearing up the bonds already.
ReplyDeleteI don't see how. The Fed only returns the interest. Tearing up the bonds would mean that the Treasury was no longer liable to the Fed for the principle. The upshot is exactly the same as if the Fed simply credited the full amount of that owed principle to the Treasury account.
Another way of looking at it is that each dollar of existing liability from the Treasury to the Fed represents a plan to extinguish a certain number of dollars from Treasury's account on a certain schedule. It would be better not to do this.
Of course, if Congress simply allowed those balances to pile up as an account surplus, and didn't authorize additional spending to go along with it, there would be no benefit.
Dan, I think the point is that the overwhelmingly debt-deflationary environment the US is currently in confers such a lasting suppressing influence on interest rates that the principle will never have to be returned. If the bonds are never unloaded back on the market, they are effectively ripped up.
ReplyDeleteAnother reason why this is not an effective policy move is that IF the fed ever found itself with insufficient treasury paper to sell on the market to suppress inflation, a government without solvency issues would be very hard pressed to provide them. So the move of assets from the Fed to the government can simply be reversed at a later point. The difference is cosmetic and it almost doesn't make sense to think of the Fed and the government's balance sheets as separate.
When the Tsy issued the tsy and the Fed auctioned them for reserves, those reservess credited to the Tsy acct were spent into the economy. So there were then the same amount of rb in non-govt (NG), plus ownership of the tsys as a financial asset, meaning a net increase in NGNFA equal to the tsys offsetting the deficit by rule.
ReplyDeleteThen the Fed buys all the tsys for its account from NG, meaning that the tsys that were owned by NG are now owned as rb, e.g., increases in deposit accounts. The amount of NGNFA is the same, except it is now held as rb rather than tsys.
The Fed holds the tsys to maturity and gives the interest to the Tsy as required. On maturity, the just rolls over the tsys that the Fed is holding. This can be repeated ad infinitum. Or the Fed can save the Fed the trouble of the bookkeeping by returning the bonds to the Tsy. The only matter that needs to be resolved regarding the latter is the accounting.
Mike perhaps check out the Brazil real.
ReplyDeleteIve noticed some substantial movement in Brazilian sourced product lately (5% cheaper)...
rsp,
Well if the maturing debt were always just rolled over directly and entirely by the Fed, that would be one thing. But that's not what happens. The Fed only buys a portion of the debt that is issued. The rest results in interest payments from the US Treasury to the more affluent deciles of Americans, and the rate of interest varies over time depending on economic conditions.
ReplyDeleteIf the Fed needs to control inflation in the future, it has other means at its disposal. It can impose a negative rate of interest on reserves, and thus drain reserves directly from reserve accounts to raise interest rates.
If the Fed introduced negative rates on rb,, then the demand for physical currency would rise correspondingly.
ReplyDeleteTom, the Fed can charge the interest on total reserves, not just electronic reserve balances - so that includes the bank's reserve balances and vault cash combined. If the Fed really wants to drain aggregate reserves it can drain aggregate reserves.
ReplyDeleteDan, banks can hold all kinds of liquid assets that the Fed can't control.
ReplyDeleteBanks can also relocate to London Dubai, or HOng Kong. They have total leverage over the US economy and the Fed cannot cause them to lose money without a deal in which they are guaranteed to heavily recoup the losses.
ReplyDeleteB TW,this threat is on the table over other matters. A dozen banks or so banks control over 60% of the market. That's why they are too big to fail. They have the country and the govt by the short hairs and can hold it hostage.
ReplyDeleteI should also mention that there is international competition over this going on now. London is relaxing rules instead of tightening them to attract finance, since the UK runs on finance.
ReplyDeleteTom, if a bank is part of the US Federal Reserve System, it can't continue to do business unless it holds dollar reserves and is integrated into the Fed payment system. So long as it is, the Fed can drain or augment those reserves, as well as doing the same for aggregate reserves across the system. If the bank wants to rip itself out of the Federal Reserve System just to avoid a reserve tax, I suppose there are ways of doing that. But it seems like and awfully draconian step.
ReplyDeleteBen can't even lower the rate to 0, let alone go negative. He is well aware that the #1 task of the Fed is to protect the US financial system and that means keeping banks profitable, which means, of course, those too big to fail. If he doesn't, they'll abandon him. He has no choice but to work with them. And Jamie Dimon put Congress on notice, too, regarding regulation.
ReplyDeleteTom, if a bank is part of the US Federal Reserve System, it can't continue to do business unless it holds dollar reserves and is integrated into the Fed payment system. So long as it is, the Fed can drain or augment those reserves, as well as doing the same for aggregate reserves across the system. If the bank wants to rip itself out of the Federal Reserve System just to avoid a reserve tax, I suppose there are ways of doing that. But it seems like and awfully draconian step.
ReplyDeleteJust watch what is going to happen when push comes to shove. Jamie Dimon as read Atlas Shrugged. I am speaking metaphorically, of course. He did not need to. Maybe Ayn Rand wasn't a great writer of fiction, but she was no dummy either. Even Greenspan admitted he underestimated the self-interest of the bankers, neven thinking that they would take the system down in pursuit of it. What Alan didn't realize is that they knew they could take the govt hostage and demand "protection insurance" just like the Mafia.
Banks only have us by the short hairs to the extent we permit them that option. We don't live in a gold standard era where banks are private owners of gold reserves that they can pick up and take to other countries if they don't like the US environment. They trade in dollar reserves which are the pure creation of the US government. The USG is in charge of its base money supply since the vast major. In a single night, the US Congress could thoroughly nationalize the whole system and rip control away from the current stockholders.
ReplyDeleteTom, Jamie Dimon's leverage consists in the fact that Americans are ideologically averse to taking the kinds of steps that would mitigate or eliminate that leverage. In the end, Jamie Dimon's business depends on US dollars, a pure fiat creation that the US government and public ultimately controls. If we wanted to turn the tables and show Jamie Dion who has who by the short hairs, we could do so.
ReplyDeleteThe USG is in charge of its base money supply since the vast major. In a single night, the US Congress could thoroughly nationalize the whole system and rip control away from the current stockholders.
ReplyDeleteYes, and the bankers know that the govt would never do that, since the people would rise up against a socialist take-over. Notice how the legal requirement to put insolvent banks into resolution was quickly spun as "nationalization," and the president immediately responded that he had no intention of nationalizing the banks.
Tom, Jamie Dimon's leverage consists in the fact that Americans are ideologically averse to taking the kinds of steps that would mitigate or eliminate that leverage
ReplyDeleteExactly, that is what the game of capitalism is based on.
Competing an incomplete sentence above.
ReplyDelete"The USG is in charge of its base money supply since the vast majority of it is in electronic form, and exists only as electrons on computers controlled by the central bank."
Yep, the key to the financial sector power mystique is the mythos they (and their lackeys in government) purvey to the public that makes the public think the US government is like a small business dependent on credit provided by the financial sector when in fact the financial sector's lifeblood is a form of credit provided by the US government.
ReplyDeleteRight, they have spent a huge amount on propaganda to that effect, but it's paid off very well for them.
ReplyDeleteHere's a public actually demanding govt surpluses large enough long enough to pay down the national debt so their kids don't have to. Which really means, of course, they have to go in much much deeper to the banks. Unbelievable con job.
I published that "tear up the debt" idea long before the four articles quoted above. That was at the end of a letter of mine in the Financial Times last Febuary.
ReplyDeletehttp://www.ft.com/cms/s/0/91d0fd48-5191-11e1-a99d-00144feabdc0.html#axzz2ABWGx6OG
MMTers are light years ahead of everyone else!!!!
Ralph,
ReplyDeleteThe idea was first proposed by Ron Paul around Mid-2011 after the debt ceiling was hit early that year.