There has been quite a bit of puzzlement in some quarters as to why I savaged BIS over the whole idea of a limitless supply of government-produced safe assets purely to meet the needs of the financial system. Firstly, let me make it clear that I do not believe that any asset is ever really "safe". Nor do I believe that global investors have any right whatsoever to expect national governments to provide them with what amounts to unconditional backing for their deposits. The first duty of national governments is to their people, not to the needs of a global financial elite. And it is quite wrong of global financial elites to pressure governments into issuing debt that they do not need purely in order to provide them with liquidity. Nor should global financial elites impose austerity measures that are not warranted by the economic situation, purely to reassure themselves that the assets they rely on for liquidity cannot ever become unsafe.
So that is my political stance, if you like. But this post is concerned with the particular effect on the US of producing global safe assets in much the same way as it has hitherto produced the world's reserve currency.Coppla Comment
Safe assets and Triffin's dilemma
Frances Coppola
Then there is also the interest subsidy.
She argues based on sector balances. Devastating. Note that she uses JKH's S = I + (S-I).
I don't agree with her conclusion, which logically leads to the rejection of government bond issuance based on her initial observation,
MMT would not agree the problem as whole, in that if the country with the trade and fiscal deficits is a currency sovereign like the US, then if the fiscal deficit offsets consolidated nongovernment sector's saving desire, the country can enjoy an advantage in real terms of trade while maintaining output and full employment. There is no operational issue with interest rates, since interest rates are set by the central bank. The practical issue is that powerful forces will demand that the market be allowed to raise rates, as she notes, but there is no reason that a politically independent central bank has to accede to outside pressure.
Adopt Warren Mosler's proposal of setting the overnight rate to zero permanently, issuing no Treasury securities in excess of three months, and run a fiscal deficit equal to the saving desire of consolidated nongovernment.
So while it is a powerful piece and makes many good points, it is not MMT-based, even though she uses the sectoral balance approach. Good shot though.
I don't agree with her conclusion, which logically leads to the rejection of government bond issuance based on her initial observation,
There has been quite a bit of puzzlement in some quarters as to why I savaged BIS over the whole idea of a limitless supply of government-produced safe assets purely to meet the needs of the financial system. Firstly, let me make it clear that I do not believe that any asset is ever really "safe". Nor do I believe that global investors have any right whatsoever to expect national governments to provide them with what amounts to unconditional backing for their deposits. The first duty of national governments is to their people, not to the needs of a global financial elite.There is no operational necessity for currency sovereigns to issue government securities under the currency monetary regime. The interest payments constitute a special interest subsidy that is inefficient and should be eliminated as dead weight in the budget.
MMT would not agree the problem as whole, in that if the country with the trade and fiscal deficits is a currency sovereign like the US, then if the fiscal deficit offsets consolidated nongovernment sector's saving desire, the country can enjoy an advantage in real terms of trade while maintaining output and full employment. There is no operational issue with interest rates, since interest rates are set by the central bank. The practical issue is that powerful forces will demand that the market be allowed to raise rates, as she notes, but there is no reason that a politically independent central bank has to accede to outside pressure.
Adopt Warren Mosler's proposal of setting the overnight rate to zero permanently, issuing no Treasury securities in excess of three months, and run a fiscal deficit equal to the saving desire of consolidated nongovernment.
So while it is a powerful piece and makes many good points, it is not MMT-based, even though she uses the sectoral balance approach. Good shot though.
No, it's not an MMT piece. Because I think that debt and money serve different economic purposes, I don't agree with the MMT argument that debt is unnecessary. Indeed when you regard government debt as a long-term savings scheme for its citizens, as I do, it is evident that governments MUST issue debt as well as money. My concern (and my post) is about the economic consequences of over-production of debt by certain national governments to meet the GLOBAL demand for safe assets, because the private sector cannot produce safe assets and neither can most sovereigns.
ReplyDeleteFWIW, I don't personally agree with my own conclusion. That is the conclusion from the "we need more safe assets" perspective. Because of the Triffin dilemma, national governments can't produce the amount of safe assets required AND commit to keeping them safe. A supranational institution could. But that doesn't mean that I'm in favour of a global version of the Eurozone. Frankly I can't think of anything worse.
What is really needed is for investors to come out of their bunkers and start accepting risk.
@ Frances Coppola
ReplyDeleteThanks for sharing your view here. Perhaps I overstated when I said, ""MMT." Warren Mosler is the vanguard for the no debt over 3 mo, setting the rate to zero, and a few other proposals wrt banking and the financial sector. I am not certain that all the MMT economists are of one mind on these points. But no one other than Warren has come out with clearly stated proposals on this either, and in Warren's view as the founder, he assumes that MMT takes the direction he sets. So in that sense it is correct to state that this is the MMT position but only with that qualification.
It would be interesting to hear in a post, or several if that what it takes, your assessment of Warren's views on public debt, setting the overnight rate to zero and abandoning monetary policy for fiscal policy iaw MMT analysis, as well as his proposals for reforming the financial system.
Ideas are being floated now such as The Chicago Plan Revisited, Richard Werner-Positive money, American Monetary Institute, etc., as well as free banking on the Libertarian side. Then there are the proposals to reform the financial sector, such as Dodd-Frank. This is turning into the next hot topic.
Enquiring minds are wondering what your assessment of all this is and where you come down now that you are coming forth as a player.
Thanks for stopping by. I look forward to reading your future posts. We agree on much more than we disagree, for example, that the EZ arrangement is no model for globalization.
One of Warren Mosler's banking proposals is to eliminate the cap on gov't insured bank accounts. If that were done, U.S. bank accounts themselves would become "safe assets" and there would be no reason to issue any gov't securities.
ReplyDeleteHi Tom.
ReplyDeleteMosler and I see the role of government debt in relation to the savings desire of its citizens rather differently, and as nearly all money is interest-bearing these days I don't think he is right about the deadweight cost of debt in relation to money. And I don't agree with fiscal dominance as MMT proponents do: I think monetary and fiscal policy both have a role to play and the two should be coordinated. So yes, I probably will write about this at some point.
I've taken apart both Positive Money's proposal and the IMF's Chicago Plan Revisited in previous posts. Of the two, Positive Money's is considerably stronger but I have concerns about their extension of the central bank's role. I think there are other models that might work better. And I have much to say on the subject of financial sector reform. I consider the current direction of regulation to be almost entirely wrong. Fragmenting the system cannot possibly make it safer - indeed history shows that a fragmented system with fragmented or two-tier regulation is LESS safe. I've been saying this in numerous posts over the last two years.
Thank you for your confidence in me, by the way!
Ken - you presumably mean the FDIC insurance cap. I could argue it the other way round - as would Lawrence Kotlikoff. Government debt is highly liquid, it implicitly benefits from unlimited insurance and it is interest-bearing. It is therefore a perfect substitute for interest-bearing insured deposit accounts - in fact it is rather better than most time deposits, because it gives faster access to savings. And it has the advantage that it can be bought by mutual funds. Unless you were thinking of getting rid of mutual funds and forcing savers to manage their own portfolios around a core of insured deposits?
Yes, I mean the FDIC cap. I agree that gov't debt is a perfect substitute for interest bearing insured accounts. But only up to the cap. Get rid of the cap, and I don't see any compelling reason to buy or issue gov't bonds.
ReplyDeleteI think the main reason investors are willing to snap up gov't bonds even at negative real interest rates is because for really wealthy investors, there is no such thing as a completely safe bank account. But treasuries provide a close approximation to that.
I don't think mutual funds would go away ... these invest in way more things than gov't bonds. But there is risk involved in mutual funds, so they are a different kind of animal.
Thanks for the clarification, Frances.
ReplyDeleteHave you seen Ahwin Parameshwaran's proposal, Unifying The Fiscal And Monetary Functions: A Policy Proposal
Ashwin's proposal quite close to what I've proposed about separating "retail" banking from commercial and investment banking, and having government assume retail as a public utility, since it already provides the guarantees. Let the banks handle the risk management of commercial and investment banking on their own without creating moral hazard.
Ashwin doesn't mention it since he is in the UK, but government agencies end up with almost all the mortgages in the US. No reason for govt not to assume this, too, as a public utility, since in effect it is doing this already wrt the risk. The government couldn't do a worse job of risk management in this regard than the financial sector has.
What's happening now is that the banks and a good part of the financial sector is now getting paid to put the entire system at high risk. Makes no sense, especially when the too big to fails are also too big to jail. It's state capture.
Ken,
ReplyDeleteI can't agree with you, I'm afraid. MMMFs offer the same guarantee as insured deposit accounts but without the cap. The only time in history that an MMMF "broke the buck" - failed to return principal - was after Lehman, and the shock of that MMMF failure was the direct cause of the freezing of the financial markets. To say there is "risk involved" is a fundamental misunderstanding of MMMF's function and purpose.
There is hardly any difference between government debt and insured deposit accounts, and there are considerable advantages to having safe deposits in the form of tradeable paper. The major purchasers of government debt are pension funds, who are required to hold a high proportion of safe long-term assets and whose portfolio management strategy involves moving from risky to safe assets as people approach retirement. Please tell me what they could use instead of government debt, since deposit accounts would clearly be impractical?
Hi Tom,
ReplyDeleteI'm in the UK too. You do know that the US's handling of mortgages is unique in the world, don't you? No other country has Government-backed securitisation of mortgages - in fact no other country securitises mortages to anything like the same extent: in most countries lenders retain loans on their own balance sheets. And no other country provides the level of Government support for home ownership that the US does, either. We don't have 30-year fixed rate mortgages, we don't have the FHA, we don't have mortgage interest tax relief and we don't have Ginnie Mae state help for housebuyers on low incomes.
FWIW I don't really agree with Ashwin on this, though I do on other matters (notably his view on the permanence of the liquidity trap due to interest-bearing money). I think the present economic situation, and in particular the direction of monetary policy, leads inexorably to a state banking system anyway, so the whole private/public debate will become redundant. The issue for me is transparency: I would rather have full nationalisation and explicit state control of banking than full state support of banking one way or another but no control. But as that would probably be politically unacceptable in most countries, the next best is to treat the whole of banking - not just one little bit of it - as a privatized utility and have regulators with responsibility for overseeing all aspects of the business and ensuring the smooth operation of the system end-to-end.
I do not agree with proposals that treat one part of the financial system as "special", provide that with full government support, and throw the rest to the wolves. That's how we got into this mess in the first place.
Of course there is risk with MMMF, unless they only invest in US Gov't securities and not commercial paper. It may not be a lot of risk because of diversification etc, but it is there.
ReplyDeleteThe only reason deposit accounts are impracticable is because of the FDIC cap, right? If there was no cap .... what would be wrong with them?
Frances: have regulators with responsibility for overseeing all aspects of the business and ensuring the smooth operation of the system end-to-end.
ReplyDeleteWhat about regulatory, intellectual, and state capture. We had all three in the US and still do. Many experts think that efficient and effective regulation is not possible long term and breaks down in Minsky's Ponzi stage. In this view, only institutional reform works. I would agree based on historical evidence.
I think the present economic situation, and in particular the direction of monetary policy, leads inexorably to a state banking system anyway, so the whole private/public debate will become redundant. The issue for me is transparency: I would rather have full nationalisation and explicit state control of banking than full state support of banking one way or another but no control.
ReplyDeleteThis is I believe is Bill Mitchell's view or close to it. I don't think he has fully articulated this yet, unless I missed it.
I am of two minds. I don't like giving either the public or private sector full and exclusive control. At the same time, due to capture, a hybrid system is turned in effect into one under private control. With a public utility, the "directors" are accountable to the people and can be fired by them come election time. That's not a possibility with the private sector.
So in the end, nationalization is probably the only financially practical solution to the problems, but it is not practical politically given the existing power structure.
Tom,
ReplyDeleteYes, I agree regulatory capture is a considerable problem. But I don't think structural reform of the kinds currently being considered will do anything whatsoever to make the financial system more resilient. In fact it may make it more fragile. We really need to consider how best to manage the financial SYSTEM as a whole, rather than focusing on particular bits of it and ignoring the rest. The reality is that every time we have had two-tier regulation, or a regulated sector and an unregulated sector, the less regulated sector has eventually crashed causing problems for the more regulated sector. There is nothing new about this - it happened in the UK in 1973-4, among others. 2008 was just the latest example of it, and a particularly bad one because of the size and global reach of US shadow banking. But please, please remember that the origin of the crisis lay in retail banking...."utility" banking is NOT "safe".
I don't think it is possible to segregate "utility" banking so completely that it is hermetically sealed off from the rest of the financial system, without seriously restricting the service customers currently receive. And if there is any leakage at all - for example, if retail banks are dependent on wholesale funding, as they are at the moment - then any large failure in the unregulated sector inevitably affects the regulated sector. I honestly don't think people understand this.
Ken,
ReplyDeleteYou seem to be thinking of government debt as "borrowing". It isn't. Government has no need to borrow: what we call "debt" is actually the savings of the citizens of the country (and also, in an open economy, foreign residents).
Government securities can be thought of as certificates of deposit, or (perhaps more accurately) preference shares. The interest paid by government to its own citizens on their holdings of govt debt is a tax credit, not a cost. Interest on debt held by foreigners is of course a cost - it amounts to an overseas fiscal transfer similar to war reparations. But interest paid to residents really can't be seen in this way.
I have written elsewhere on interest rate parity in a fully floating exchange rate regime, and why I think the real cost to government of debt and money over the medium term is the same. I do not accept your argument that governments should always prefer issuing money to debt. Money and debt have different purposes and different economic effects. Both are necessary.
I do not think of gov't debt as "borrowing" in the way normal people use that term. I agree with the MMT position on this. I also agree gov't debt is private sector savings, as you say.
ReplyDeleteMy point is ... if the FDIC cap was removed and gov't instead guaranteed all accounts at commercial banks with no limit, these accounts could serve exactly the same roll as gov't bonds do now.
So the gov't no longer issues bonds, and deficit spending accumulates as excess bank reserves. If the gov't chooses to pay interest on these reserves (doesn't have to ... can leave the interest rate always at zero, like many MMT people advocate), competitive pressures would force the banks to pay close to that interest rate on its deposits.
This would really be no more than rearranging the furniture on essentially the same system we have now. So now we have safe deposit accounts instead of safe bonds. But it would make very clear that the gov't, not the "market", ultimately sets the interest rate, would make clear that what we formally called debt is actually private savings, and should expose as silly the gov't spending sustainability arguments we engage in now.
Above should read "So now we **would** have safe deposit accounts instead of bonds". Just realized the way I worded it might cause confusion about what I meant.
ReplyDeleteKen,
ReplyDeleteI don't think you need to abolish government bonds in order to debunk the myth of government debt. All you need to do is, well, debunk it. All forms of government debt are private sector savings. In the UK we have a government savings bank that issues certificates of deposit. Would you ban these too? After all, they are government securities just as much as as gilts....
Frances, in the estimation of many, it's the govt as big firm or household analogy that is at the root of the problem. This is fostered by the veils over actual operations and the smoke and mirrors of politically imposed restraints on operations that could otherwise be streamlined and make obvious at the same time.
ReplyDeleteIt seems to many also that the easy way out would be to go to direct issuance from Tys instead of the deficit offset requirement with debt issuance to accomplish essentially the same thing as far as increasing consolidated nongovernment net financial asset in aggregate ($NFA) is concerned.
The route of creating $NFA through issuance of tsys for rb circuitously through the private sector (PD's in the US) creates a perception that is incorrect and possibly intended to be so.
As far as educating the public about the reality, The transaction cost in terms of time and expense of effectively educating the public would be prohibitive in my view. Polls show that public ignorance in the US is at the abysmal level, and scientific studies also show that rational argumentation that runs up against ideology simply results in ideologues doubling down. Moreover, even experts are either confused or in denial when the truth about operations is described to them. I just don't see the educational route working when we are already having so much difficulty explaining it to experts in a way that they can get.
So I would recommend cutting to the chase. By going to direct issuance without a public debt offset of the deficits, sufficient safe assets could be provided by offering term deposits at the Fed — which tsys are anyway, as Warren observes. The Fed could then set price and let quantity float iaw demand, instead of issuing a fixed quantity of public debt determined by the size of the deficit, which regularly results in a shortfalls and gults of debt. On demand issuance of term accounts would be more efficient.
This leaves the existing system intact and actually improved by making safe assets available in the quantity demanded, while drawing back the veils that conceal what is actually going on.
Term deposits at the Fed, or simply have the Fed guarantee depositors at commercial banks with no cap. Either way ... no need to issue "bonds". Bonds are linked in the public mind with "debt", and getting away from them may be the only way to break that perception.
ReplyDelete