- A "strong dollar" doesn't mean a strong economy
- The government is going to have to pay for its debt, not inflate it away
- Some inflation is all right
- The gold standard won't solve any of the problems people think it will
To explain why I think the risks lie in the directions of fiscal crisis rather than hyperinflation, I turn to Tyler Cowen, who elegantly summed up the government's problem at a conference I attended last week: inflation only works on stocks of debts, not flows. You can inflate away the value of debt you've already issued, but especially in these modern times, bondholders will rapidly ratchet up the interest rate they charge you. They will increase it by more than the rate of inflation, to compensate them for future inflation risk. Losing your credibility is costly.
To this, my excellent former co-blogger Winterspeak responds that since the United States has a monopoly on the currency it issues, it can't default--it can just keep running the printing presses. There are a couple of problems with this. In some sense, I think it confuses cause with effect: the government gets to borrow in a currency over which it has a monopoly, because it has been a fairly credible steward of that currency. If it inflated away its debts on the scale of, say, a Latin American nation, it would not be able to borrow in dollars any more. And since it needs real goods and services, not little green pieces of paper, that matters.
For his point to be right, you need to believe that the government can end up financing the entire debt by seignorage, which is the revenue that the government gets from issuing currency. In the case of the United States, that revenue is currently pretty considerable, because so many people overseas use dollars as their emergency bank account; essentially, they give us goods and services in exchange for dollars, and then stash those dollars under their mattresses. But that's because we don't inflate the currency.
In the case of a hyperinflation, essentially, the government gets a slight discount, based on the fact that it knows how much money is in existence, and you don't. It prints the dollars, and uses them to buy goods, and then the oversupply of dollars pushes up prices still further. But the discount is actually pretty small, and hyperinflationary seignorage turns out to be a very inefficient way of generating tax revenue, especially in a world where there are modern financial markets monitoring government behavior. The much maligned Laffer Curve is actually a pretty effective model at describing hyperinflation; it's very easy to get on the wrong side, where inflationary expectations and deadweight loss start killing the revenue you can raise. It is possible to end up in a place where, as with the Zimbabwean dollar, your monopoly right to print your currency becomes worthless, because the demand for that currency is essentially zero--no one will give you goods and services in exchange for your paper.
If you're talking about a past stock of debt, it makes some sense to talk about it solely in terms of dollars--really, accounting entries. But of course, the reason the government borrowed the money is that it needed to secure real goods in the economy, and its citizens didn't want to reduce their consumption enough to pay for it all with their taxes. Sometimes that's a one time event, like a war, in which case inflating away your debt looks quite attractive (immoral, possibly--but then, lots of attractive things are immoral, n'est ce pas?)
But more often it's an ongoing problem. In which case, it's hard to aggressively inflate, because within a very short period of time, your ability to borrow in your own currency at attractive rates will fall off. So if you're going to hyperinflate, you need to be prepared to quickly close the gaps between the real goods and services you want to consume, and the real goods and services you want your citizens to give up in order to pay their taxes. In other words, you need to be prepared to stop running a budget deficit--or to resort to increasingly desperate tactics like Argentina's nationalization of its private pension regime in order to loot the accounts.
In the US, the problem is even more complicated because so many of its mandatory payouts are inflation-indexed; it doesn't do you any good to inflate your debt away if half the debt is owed to inflation-linked Social Security accounts.
I am the last person to ascribe any towering wisdom to our nation's political class. But they do (most of them) understand this calculus. Moreover, the US has an unusual degree of continuity, and power, in our legislature; to do something this drastic, you'd need to secure the assent of a number of congressmen who are planning to be working at the Capitol for several more decades, and thus have an interest in not seeing the fiscal mechanism by which they distribute goodies to their constituents entirely break down. If interest rates start accelerating on our debt, or treasury auctions fail, I think they're more likely to take some sort of drastic step then to either default, or hyperinflate.
The key word is "drastic"--I expect they will let us get into quite a pickle before they finally reign things in. But there are really quite a few institutional checks that will prevent things from going the way of Latin America, not least that we have a central bank with a lot of political independence. For all the complaints about Greenspan and Bernanke's inflationary bias, neither were prepared to countenance even high single-digit inflation, and I doubt Bernanke's successor will be, either. The first step to hyperinflating would be some sort of radical step to curtail the Fed's power--and that radical step would, as noted above, make it very hard for the government to borrow new money.
I think the much bigger worry is that we are going to drive ourselves into a corner where the bond markets will force us to slash benefits to people who have planned their lives around them, making those people worse off than they would have been if the program had never existed. And also, of course, that they will raise taxes by enough to produce serious, painful deadweight loss. But until Ben Bernanke starts looking much more inflation-friendly than I've so far seen, any kind of effort to totally inflate away our national debt is pretty low on my list of potential problems.
Well, that sucks for those of us with large fixed-rate debts.
For someone who hangs out with libertarians a lot, announcing that you're okay with a small amount of inflation to relieve the sticky price problem, and that you think the Fed mostly does a good job, is akin to announcing that you've decided to take up human sacrifice to fill those lonely weekend hours
Tell me about it. And the goldbugs drive me nuts.
I think people generally underestimate the extent to which billions of people outside the country are expending huge amounts of effort to sell us things as cheaply as possible.
A "strong dollar" doesn't mean a strong economy
Indeed. Exports up 21% last Q.
Exports up 21% last Q.
Doesn't that violate the tacit agreement with the Chinese? I wonder how they feel about it.
Indeed. Exports up 21% last Q.
Well, it's nice to know that useful goods are being sent overseas in exchange for little pieces of paper. That's what I call economic strength!
What would you prefer?
the US has an unusual degree of continuity, and power, in our legislature;
Which is a problem when you need a supermajority to do anything because a minority refuses to (seriously) raise taxes, (seriously) cut spending, or both.
I'm a Californian, so this has a really familiar sound to me. . . .
If by "seriously" you mean at all, then I agree. The major expenses haven't been cut. In fact, reductions in the rate of INCREASE are politically impossible these days. Anything but exponential increases in spending is derided as draconian "cuts".
Meanwhile, looking at our current tax system, I can't help but wonder if we're on the right side of the laffer curve already. With the complexity of the system, its tremendous accounting costs, and the risk of criminial sanctions, the cost to the payer can be ruinously high even if little revenue is actually raised.
So option 3, inflating the currency, may be bad for the US in general, but you have to look at this from an agency perspective. It "solves" the immediate problem of accumulated debt, at a time when there aren't any villians left with assets to tax. Inflation is an "after next election" problem. It can also be blamed on the Fed (much as certain of the banks can be blamed for taking TARP funds they were ordered by the government to accept).
But here's the real test: if inflation is so self-evidently counter-productive, why do any countries do it? Why did WE go through a period like this in the 60's and 70's? What about other counter-productive things, like taxes that are dysfunctionally high and complex? Or unsustainable spending growth? Why are we running up a debt in the first place? Barney Frank and Chris Dodd are making vast political hay out of a crisis that was largely their doing-- so fear that the electorate will attribute a disaster to them seems far-fetched. In any event, did mortgage traders behave as you describe? Did dot-com investors? What about the Roman Senate?
In one interview, President Obama was asked about capital gains taxes and the Laffer curve. He specifically accepted the premise (that lowering the tax would increase revenue) but then explicitly stated that he wanted it higher anyway, as a social justice measure. So I guess my point is that you're saying that the government will be rational because they should be rational, and because they've been somewhat rational in the past. I'm arguing that looking at many nations throughout history, nations usually aren't rational in their economic policies (or at least they don't optimize national interest).
I do agree that the gold standard isn't the answer, and I agree that the fed has done a pretty good job overall.
Megan, What is your take on the increase in money supply?
http://www.chartingstocks.net/2009/03/chart-of-the-us-money-supply-1917-2009/
Well for starters, it ought to be charted on a logarithmic scale. But yeah, that's one hell of a spike either way. Still, be curious to see how it matches up with the regression on the 1917-2001 part of the data. Bet it wouldn't look so scary then.
I'd say that for starters one shouldn't confuse the monetary base with a more appropriate measure of money supply like M2.
What is your take on the increase in money supply?
Well, if you are talking about that spike straight up at the end, I'd say "MV=PQ".
Then you can see another chart with a line going exactly the opposite way, straight down. Put 'em together...
The reason hyperinflation is a legitimate concern is due to the consistent failure of our political class to arrive at a rational fiscal policy. The general consensus within the party in power is that we can sustain and increase current spending trajectories with tax increases that hit an ever smaller portion of the population. The House health bill is a great example. We are supposed to believe that the people earning over $500K/year can carry much of the freight for reforming the system.
Meanwhile, larger and larger portions of the population are either off the tax rolls entirely or, even worse, are supplicants to the government receiving net benefits even in their working lives. To the extent that voters do not pay taxes but continue to vote, rational self interest will lead to support for candidates promising more free benefits.
Of course, this economic policy will eventually collapse - the rich may be many things but they are not stupid. Static revenue models will fail. It has already happened in California and New York state.
So, with ever larger numbers of voters essentially viewing themselves as free riders, spending pressure will continue to increase while legislators will be unable to impose broader taxation on their constituents without being booted from office.
Something must give. What will it be?
Will voters accustomed to a free lunch support candidates who will either trim their free lunch or raise taxes on them?
Will the rich placidly pay more and more taxes to support benefits from their non taxpaying fellow citizens?
I don't see either scenario playing out. And eventually, the weight of the debt will be too much to carry.
Keep in mind - interest rates are at generational lows and we still have horrific payments on the debt coming up on the horizon. What happens when treasuries go back to yielding 6 or 7%? What does the fiscal balance look like then?
If there is a way out of this situation that does not involve at least a brief period of significant inflation (double digit) I will be very surprised. What happens once inflation hits will be key. We may have another early 80s reformation, or we could go the way of a banana republic. There is no way to know which will be the chosen path ahead of time.
Oh, and those entitlements indexed to inflation --- indexation is not written in stone. Ultimately, if society cannot furnish the tax revenue required to support these real claims on wealth, indexation will be abandoned.
I'm not running off and buying gold and putting it in a vault, but any investment I make must pass the inflation test - can the business deal with inflation or not? It would be nuts to do otherwise.
Yep. She didn't say that hyperinflation would be impossible, just that it would be really, really crazy and shortsighted. So I'm not comforted.
While I certainly hope your analysis is correct, you'll pardon me if I don't put much stock in a theory which has as one of its central supports the enlightened self-interest of Congress. Enlightened, that is, in their understanding of basic economics and how it plays into their love of giving other people's money away. Congress is, so far as I can tell and even in spite of the tremendous incumbant longevity upon which your argument rests, populated nearly entirely by complete ecomonic illiterates.
The independence of the Fed. is more encouraging, I agree, but two points against that:
1) While Greenspan & Bernanke (so far) have been unwilling to see inflation above single digits, I think a quick perusal of our central bank's history will reveal at least one period in which the central bank either countenanced or was unable to prevent double-digit inflation.
2) When you have a president as popular as Obama is who chafes as visibly as he does under the relatively loose contraints of the exceedingly abundant power of his office, can one be entirely sure that he won't be pushing as hard as he can (with "as hard as he can" shortly including the appointment of his own chairman) for the Fed to fall in line with whatever he feels is necessary?
Now, I know Obama is an amazing economic thinker and has surrounded himself with still more amazing economic thinkers so we needn't worry about his bona-fides in that respect but still, every now and then this administration seems to say or do something in the economic sphere that, were we not already convinced of their surpassing brilliance, would seem to betray an almost idiotic lack of economic insight.
One might even term it a "Congressional" level of economic understanding. Oh, but that's right, we needn't worry about Congress screwing the economic pooch either, because they know enough to keep their own gravy train rolling...
"the government gets to borrow in a currency over which it has a monopoly, because it has been a fairly credible steward of that currency."
According to the inflation calculator on the BLS website, the dollar has lost 95% of its value in less than 100 years. I guess it's a good thing the government has shown itself to be a credible steward of the currency, no? I mean- suppose they hadn't been? How much less would a dollar be worth today than it already is, compared to 1913?
Excellent screen name, btw.
So what? I'm borrowing, spending, paying, and being paid in current dollars, not 1913 dollars. A 3% per year rate of inflation (backed out from the figures you cited, if they are accurate) won't seriously impact my ability to do any of those things. I'm not worried about inflation unless it's serious enough to be worth accounting for in day-to-day transactions or major purchases.
I do grant you that there have been points over the last hundred years where that has been true in the US. (Ask President Carter how the 1980 election went)
seriously, not sure, you really need to read some econ 101 about inflation and money, etc.
According to the inflation calculator on the BLS website, the dollar has lost 95% of its value in less than 100 years.
Yep, to stay even with that you'd have had a to have invested at a good 3%. Say, in a savings account. (If instead you kept your currency in tin can buried in the yard, yes you'd have lost.)
Of course that average for 100 years masks periods when the dollar actually gained value.
For instance, from 1929 to 1933 it gained a whole lot!
During just this past year it's gained in value too.
So look at those bright patches, things haven't been all bad.
To advocate the gold standard is to not understand anything about economics and finance and should therefore are making a fool of themselves
Are you paid in 1913 dollars? How much better is life now than in 1913. Surely, everyone agrees living standards now are much higher for everyone than in 1913.
Gold is not magical. The only reason it is useful is because you can trade it for stuff you want.
"Are you paid in 1913 dollars?"
Of course not. But I *have* been paid in 1970 dollars, meaning that for every one of them I tried to save, I need more than 5 1/2 of the current version in order to have the comparable purchasing power today as then.
In order to have turned that one 1970 dollar into 5 1/2 2009 dollars, one must have invested in- something- that increased in value enough to cover not only the loss in purchasing power, but to pay taxes on the "profit" one made.
Nice scheme- tax people on their income, then tax that same income again when people have the nerve to try to keep from having their savings evaporate.
Yeah- inflation is no big deal.
Yup, one must have invested in something that had an interest rate at least as high as the inflation rate to not lose any purchasing power. That is not hard to do at all. Do you think its just a coincidence that the risk-free rate got up to 13+% during those periods of inflation? If it was impossible to save money at a rate higher than the inflation rate, no one would save. But, not only is it possible, its actually quite easy to do so. This is not a concern at all.
I was paid in 1995,96, 97, 98,99 (shall I continue?) dollars and saved them. My parents finished earning all of their money in 1990 dollars. What happens to them?
Don't put up a gold straw man. Answer the question about how well off we will all be when the government has to dispense with this debt in the best way for them.
Nonetheless, I stand by the sentiment: inflation is not the big worry that our economy faces.
Problems I have with inflation: It is taking money from me in a way that denies me any input into the process. It is a hidden tax or even theft. Even this might be ok IF the money were put to good use. But seriously - do you trust the government to get this right? After the stimulus bill experience?
Do you trust them to know when to stop? Once you open that door, it will always be - "just a little bit more won't hurt us".
MEGAN: "the government gets to borrow in a currency over which it has a monopoly, because it has been a fairly credible steward of that currency."
Does this really make any sense to you? That a monopoly currency issuer must borrow the one thing that it can create, without limit, itself? It's like borrowing your own signature from someone else, it just makes no sense if you think about it for a moment.
This is what happens when the Treasury sells a govt bond: someone buys the bond, which debits the reserve account, and credits the Treasury account.
That's it. So, the reserves to buy the bond have to exist already, and all buying the bond does is subtract a number form one account and add it to the other. It changes the term structure of outstanding assets, it does not change the quantity of outstanding assets.
When the bond matures, the Treasury account gets debited, and the reserve account gets credited. It is the exact opposite of the prior transaction, and again, changes the term structure and composition of outstanding assets, but does not change the quantity of outstanding assets at all.
The US does not "finance" its deficit through issuing debt. The US issues debt to change the term structure of outstanding assets, in particular, to drain the reserve account so the overnight interbank lending market can have an interest rate above zero. Treasuries should be thought of as an interest rate maintenance account, not "borrowing".
Zimbabwe destroyed half of its real output. They would have had hyperinflation even if they had been running a balanced budget and not printing any new currency.
Just as the Govt does not need to borrow to be able to spend, it does not need to tax to be able to spend either. The Govt can just spend, and does, by crediting reserve accounts. It taxes to 1) create demand for its currency, 2) reduce aggregate demand (and thus keep inflation low), and 3) redistribute wealth.
Who will accept an asset that consists entirely of the right to be paid dollars in the future when they expect that those dollars will be worthless paper at the end of it? The US might not "finance" its deficit by borrowing dollars, but it finances its spending by borrowing productive capacity denominated in dollars. No amount of technicalities will change the fundamental nature of the transactions involved.
You are focusing far too much on the technical process and far too little on what the reactions to those "simple, harmless" transactions would be. Your continued insistence on making this pedantic, shortsighted, meaningless point baffles me.
ALSADIUS: Anyone who holds a $ bond will get the $ reserves when the bond matures. Their account will be credited, so it isn't a matter of "acceptance"
And US does not "finance" its spending by "borrowing" productive capacity either. It just credits the account, and buys the capacity.
The real wealth of an economy is everything it produces. Taxation means that the economy can no longer afford all of its output. Govt can then credit the non-govt account for remainder output without triggering inflation. Taxes, in this case, serve to reduce demand, not to "fund" spending.
Knowing how the financial system actually works is critical to saying anything intelligent about it, despite your protestations to the contrary.
Some simple points, which are obvious if you know how the financial system works (at a very shallow level of technical detail) but are impossible to understand if you do not:
1. Government deficits fund net private sector savings.
2. Government does not need to tax in order to spend. In fact, Government spending is what gives the non-Govt sector money to pay its taxes and net save
3. The Govt issues Treasuries to maintain a FFR rate above zero, NOT to fund deficits
4. Current account deficits do not mean that foreigner Governments are funding US spending, it means that the US Govt is funding foreign saving
5. Bank lending is not reserve constrained. Therefore, excess reserves have no impact on anything (except to drive the interest rate to zero).
6. When a bank makes a loan, it creates the deposit which "fund" that loan.
7. Private credit extension sits on top of net private savings, which is funded directly through Govt deficit spending.
Specific to this crises, you have a non-Govt sector that is trying desperately to increase nominal net savings, and all kinds of people, completely ignorant about how monetary operations works, uttering garbage like "the US is going to default, the US is going to have hyperinflation, the deficit is too big, what if foreigners choose to stop lending to the US" etc. etc. etc. all of which are complete rubbish.
If you think these distinctions are "pedantic, short sighted, and meaningless" that's fine with me.
The real wealth of an economy is everything it produces.
I think this is a common error. The real wealth of an economy is everything it consumes. The purpose of production is consumption; excess production is worthless.
Nope. Excess production can be set aside for the next period, either as inventory or investment. This is accounted for as "savings".
Note the causality, investment is accounted for by savings, savings does not "fund" investment.
Winterspeak, that's also wrong, because savings that are not reinvested are worthless, and you can have high savings that are not effectively reinvested (c.f., Japan).
Winterspeak-
Nope. Excess production can be set aside for the next period, either as inventory or investment. This is accounted for as "savings".
I'll bet you cornered the market in those "Arizona Cardinals- 2008 Superbowl Champions" T-shirts...
Virtually every point you just made is either true only in the most pedantic sense, or simply outright false. And before you say that I don't know how any of this works, I'll say that I have a degree in economics, and have studied all this academically. I'm not just a rube making random claims for the sake of it.
T-bills are not issued to banks without the permission of those banks - the Fed doesn't just say "Yeah, we just gave you half a bil in bonds, FYI". So if the bank doesn't buy the bonds, it doesn't matter what happens to the unsold bond at maturity.
Taxation does not mean that the economy cannot afford to consume its output. Consider a simple economy with 100 people, 100 people's worth of food produced, and 1000 dollars. Food sells for $10/person. A government levies a wealth tax of 90%, and takes $9 off everybody, and buys nothing with it. Food now sells for $1/person, and everybody still eats. The next year it sells for 10 cents a person, and everybody still eats. An obscene level of taxation, but it doesn't prevent any consumption.
1) So the private sector cannot save on net unless the government is running a deficit? Hilariously untrue.
2) True, if said government is short-sighted and insane. Weimar Germany, modern Zimbabwe, and all the other companies that try to spend without taxing usually manage it for about six months, and destroy their countries in the process.
3) If the government wants to avoid the economic suicide that comes with financing their expenditures with the seignorage tax, they issue Treasuries to fund deficits. Since they do want to avoid that(judging by the fact that it's one thing even Congress hasn't managed to bugger up in the last 233 years), they're borrowing money because they need to actually borrow money.
4) It means both. Foreigners produce goods for American consumption, and are paid in claims on future American production. For the foreigners, those claims are inherently savings, for the US it is deficit-financed spending.
5) Reserve requirements do ultimately constrain lending, though I don't have enough practical experience with the balance sheets of banks to say how much that matters in practice. You're right that excess cash does try to get lent out though, which does tend to lower interest rates.
6) Not directly true, but close enough.
7) Yes, private loans are financed by savings. No, private savings are not financed by government deficits.
As for the concerns you list, I don't expect hyperinflation or a default(though I do expect higher inflation than we're used to), but the concerns about the deficit and the possible lack of foreign creditors are real, valid dangers. If the deficit is too big and stays too big, and foreign creditors stop loaning, then either the deficit is going to get addressed in incredibly painful fashion or hyperinflation is going to happen. Even under your head-in-the-sand-onomics, that's what happens - if you can't borrow, and won't tax, you have to print, which means hyperinflation.
Winterspeak,
They destroyed half their output, not 99.999999999999999999999999999% of it.
Monetary cranks have always believed as you do, and history is replete with their actually implementing some of the things you claim the US Government could do if it wanted to, and the results have never varied- collapse of the currency always occured.
LOL! I believe that 50% is probably enough for hyperinflation!
A currency remains viable so long as the Government that issues it is able to tax. I don't know what you are calling a belief -- I'm simply describing how the monetary system actual works in real life, as opposed to the variety of just-so fables that everyone is so fond of trotting out.
Please point out anything I've said that it is "belief" and not labeled as such.
All else being equal, a halving of output will double price levels. If Zimbabwe had just experienced a mere 100% one-time inflation, they wouldn't be the laughingstock they are now. The other 99.999999999999999998% of the currency's loss in value came from running the printing presses. And if you think the Zimbabwean dollar is viable, I'd be happy to sell you some. I'll give you a real deal, too - a million of their dollars for every one of yours. How's that sound?
It makes sense to me. Money only has the value people collectively ascribe to it. The government can (and does) create more dollars by twiddling a few bits in a computer, but they can't do it excessively without repercussion. Have you been watching the greenback's slide against other major currencies?
Money keeps you out of jail every April 15th. So long as a Government can effectively tax, its currency will have value.
And yes, the $ has been going down lately, due to portfolio shifts. This is a short term phenomenon, long term, the wealth of the US will be driven by its real output (which has been depressed by high unemployment for the last year and does not seem to be easing up any time soon).
In the short term, a weaker dollar means more exports, fewer imports for the US, and thus worse terms of trades. It's funny to hear this concern from people who also worry that "China may stop buying US debt" as it's two sides of the same coin.
The mistake Megan makes is to assume that all (or most) of the argument that hyperinflation is coming stems from a belief that the government can run the presses to get out of debt.
But she fails to address entirely the argument that the money that will lead to inflation has already been printed/--and not with the goal of paying off debt, but just to keep the banks and economy afloat.
Look at the graph of money supply that someone above linked: http://www.chartingstocks.net/2009/03/chart-of-the-us-money-supply-1917-2009/
As most of us know, all that money is sitting in the banks as reserves against their debt right now. Well, what exactly to you think is going to happen when the banks start trying to put that money into circulation? The economy can't possible absorb that many dollars chasing the amount of goods and services in existence. That means inflation. A LOT of inflation. The value of the dollar will diminish as the banks try harder and harder to find places to put their money with too few takers to eat up the cash.
Can the Fed react in time or effectively enough to stem the tide? Maybe.... But it would be unprecedented and it would require at least an acknowledgment of the danger of inaction. But heretofore, the Fed crowd seems a little to sure there's not really a problem to begin with. How am I supposed to feel confident they'll come to their senses in time once the spigot has opened?
I'm not one of those Fed haters, though I know I sound like one. I just believe in the fallibility of man. In order to believe that the Fed can stop the flood of inflation, I'd have to believe in supermen.
Nessuno:
It's much worse than that. The Federal deficit *is* net private sector savings. The money the Federal Government spends but does not tax back is the money the non-Govt sector uses to net save. They are mirror images on a balance sheet.
The excess reserves piling up are meaningless, since banks do not lend out reserves, nor are they reserve constrained in any way in their lending.
Alan Greenspan thought that
The Masters of the Universe
were rational men, trustworthy;
Why do you expect CongressCritters
to do anything except ride a
Busted Flush down in flames ?
Is this about inflation, or hyper inflation?
Or is it an attempt to influence the policy direction?
There are two groups in the economy. One group is over leveraged, be it banks, home owners, businesses, commercial property owners, etc. A stimulus, printing money, low interest rate policy is great for these folks.
The other group are those with retirement savings, with large equity in their homes, with well run businesses that have cash and assets and little debt. Printing money, inflation, deficits and low interest rates mean a gradual but real depreciation in the value of their assets, and the likelihood of confiscatory taxation in the future.
One group will be favored at the expense of the other. We are in an odd zero sum game situation, and whoever can lever the political winds will either lose badly or gain.
Derek
Moreover, the US has an unusual degree of continuity, and power, in our legislature; to do something this drastic, you'd need to secure the assent of a number of congressmen who are planning to be working at the Capitol for several more decades, and thus have an interest in not seeing the fiscal mechanism by which they distribute goodies to their constituents entirely break down.
The big problem with this Megan is that while you are correct about their desire to stay there forever their view is broken up into an endless series of 2 year chunks, and specifically they are *only* concerned about distributing presents in the few months prior to each election.
This is excellent food for thought. I'm going to mull it over and then link it on my blog.
I've been in the inflationist camp. You have a valid point about debt stocks vs. flows, but I still think it might be the politically easiest solution to do a one-time monetization of the debt combined with more responsible fiscal policy going forward.
The present time may be a unique opportunity to monetize the debt, because the deflationary credit contraction may offset the usual inflation. In fact, that seems to be the plan with the Fed purchasing Treasury debt. Let's see if they resume/expand that.
As for Fed independence, that myth died when Bernanke and Paulson came out joined at the hip to terrorize Congress into passing the TARP and then bully Ken Lewis into buying Merrill.
Either inflation or default is certain, in my view. We are in far too big a hole to ever grow and tax our way out, and Obama is still digging.
How big is hyper?
If some inflation is OK, how much?
Can I agree with you about the strong dollar and gold standard, while disagreeing with you about hyper inflation, or must I agree/disagree in total?
Back in '81 I took my student loan money at 7% and had it in a brokerage money market account at 14%. I interviewed with PNB. At the time they had a deal for employees. Mortgages were 75% of the market rate. That meant a mortgage at a mere 12%. Lucky me.
I truly expect a return to this level of inflation. I don't know if would categorize this hyper or not.
No, hyperinflation is generally defined as being far higher - 100%/month is on the low end of hyperinflation. Carter-era inflation is caused by loose monetary policies, hyperinflation is caused by the government using printing presses to pay the bills. There's a massive gulf between the two.
So, to echo Gman,
How about inflation? How about 10-15% inflation for a decade?
Care to do the calculation on what that does to our savings? Our retirement? Those on fixed incomes? Those trying to save for college? How about just those trying to pay the bills?
Well, the interest rate that you save at would also increase, as would your income. Its not like that if inflation goes up, all else stays the same.
P.S. It's kinda funny that the Atlantic carries both thought-provoking stuff like this and Andrew Sullivan's demented drivel.
The scary chart linked here twice is labelled "the money supply" but it's not. It's the monetary base, the reserves the FED has placed at the banks, which could be lent. The money supply, is the base expanded by the multiplier. The velocity of money is not a constant. The machinery of the money multiplier is the banking system, and, until two-years ago, the unreserved, shadow banking system of GMAC, Indymac and the rest. The economy was extremely levered, confidence high, velocity high. The banking system is severely damaged by losses from carrying 50x leverage in mortgage and credit-card based assets. The shadow banking system has disappeared. Last I looked banks are taking credit card interest rates to 30% when they aren't canceling credit altogether. Home equity lines are cancelled. How does a new small business get funded? The bank least damaged by the crisis, Goldman Sachs, does not make loans as such. In order to trade securities with GS you must post collateral. So at the moment "cash is king." GS has $173 bln of cash sitting on the balance sheet. They are not particularly concerned about it being "inflated away." On the contrary, cash appreciates in terms of real goods at the rate of deflation. As the multiplier crashed, the cash-rich won big. So we aren't too concerned for Granny, clipping coupons, this year.
If you really believe inflation is coming, go buy another house, or better yet, a commercial building, with a thirty-year fixed rate mortgage. Crisis solved. It's a two-fer: the asset appreciates and the debt devalues at the inflation rate. With inflation back, velocity must be high. Surely your tenant can keep up the rent. But, nobody wants to do this at the moment. And the bank won't lend, even if you did want to lever-up. It begs the question, doesn't it?
CAMP: Banks don't lend out reserves. There is no multiplier.
Velocity sure can change though!
Mr. Bernanke is counting on his brand-new authority to pay interest on reserves in order to discourage bank lending or regulate the amount of lending into the economy done by this "credit channel." The idea seems to be that the taxpayer via the FED pays the banks an interest rate for being prudent. It will fascinating to see just how high the FED's "coupon" on reserves must be raised to dampen lending. At the moment it looks more like trying to light a wet squib.
Also I am not sure what you call GECap commercial paper issuance translated into small business equipment finance and auto loans but it looks like a multiplier to me.
No.
Bernanke has let reserves climb to high levels in the banking system because he thinks banks lend out reserves (as does ALSADIUS). They are both wrong. In Alsadius' case this is unimportant, since he's no one (just like me), but in Bernanke it shows the utter incompetence of the Obama administration.
Ordinarily, this would set interest rates to zero. Bernanke wants them slightly above zero, so he's paying interest on the reserve directly to set the FFR.
Reserves have nothing to do with bank lending, so unsurprisingly (if you know how any of this works) his policies have had no positive effect.
Banks lend based on borrower demand, borrower credit worthiness, and capital requirements. I call GECap commercial paper issuance extending a loan.
I hope Megan is right, but I'd feel a whole lot better if I saw any sign whatsover that we'll ever be able to pay down that debt -- or even stop its growth.
At some point we're either going to have to stop borrowing and start paying, or we're going to have to inflate. The latter is suicidal for the country, the former is suicidal for our elected representatives. I have no faith that these elected Representatives will make the right choice.
1. Even assuming no "hyperinflation" (defined as..50%, 100% inflation?), I think the issue is a more a 1970s/80s type of inflation in the low double digits. This is certainly possible, and would not be inconsequential.
2. Yes, alot of the $$ being printed are being held on bank balance sheets and not being lent, so the velocity of money is low despite the increase in the monetary base, but if one assumes a recovery, then this money will eventually be lent out. If there is no recovery, we can expect more "stimulus" more increase in the monetary base until the money starts to circulate.
3. Regarding COLAs, the CPU is a flawed statistic that is routinely massaged to reduce apparent inflation. Moreover, the obssession with "core" inflation (or "hobo" inflation, for those who have no home to heat, no car to drive or subway to take and dont go shopping for food), also appears designed to ameliorate inflation fears.
4. Although we dont have price inflation now, we also dont have significant price deflation (except in specific asset classes like real estate) despite the worst recession since the depression (supposedly) - perhaps this is actually a sign of nascent inflationary pressure?
5. Despite our own deleveraging, there are other rapidly growing economies in the world (China, India) that require commodities such as oil and metals. They will help keep commodity prices up.
6. After the massive 1990s economic "boom" (fueled by cheap credit), we are left with a huge (and growing) deficit, we are a net debtor to the world. Our financial system was also shown to be teetering on teh brink of diaster. I dont know that we are considered such great "stewards' any more.
3) The CPI stats aren't that badly massaged. Yeah, they use hedonic measures of inflation(i.e., they hold product quality fixed over time in their calculations), but that's a fairly reasonable decision, even if it does lower CPI - it's reasonable to argue that non-hedonic inflation measures would be an artificial increase. As for core inflation, it's designed to get at the real data, instead of it being swamped in volatility. Food and energy prices tend to trickle through the economy if they're sustained(since both sectors are fundamental), so you don't need to measure them directly to measure the effect they have.
4) Depends how well they do at reversing all that helicopter money when the economy picks up. Still, from what I've seen that was planned for, and it seems like there's a good chance of it working out. But yeah, if they blow it, it could be bad.
6) You don't have to be perfect, which is fortunate. The US still qualifies as "fairly good" though, I'd think, at least when it comes to currency stability.
Stop thinking in terms of what is good for America -- as if that might be a limiting factor on the behavior of our political class -- and think of what is good for the politicians. They are spending so much money they are creating a credit financed fling, rather than a recovery, for the US economy. They assume that a 12 trillion dollar deficit over the next decade would give an appearance of returning prosperity and thus get them reelected -- while making the electorate more dependent on the government. This crowd will burn through all the "goodwill" and "good credit" that previous generations of Americans have built up without giving it a thought -- if it will cement their power. They're approach: We will spend excessively now; Someone else will have to tax very excessively later.
But you are right. Inflation is not the real worry. It is our current crop of rulers.
The Administration's economic gurus are marinated in the "Keynesian approach." So perhaps they believe in the Phillip's Curve, also? If growing inflation brings down unemployment and this helps them at election time -- why not inflate? Because it will have an effect on future interest rates? Of course they will inflate. And when the bottom falls out later, they will extend unemployment benefits.
"But they do (most of them) understand this calculus."
I don't think the politicians in all the other countries that have had hyper-inflation were dumber than our American politicians. Somehow, they thought their actions were advantageous for them at the time although they led to hyper-inflation.
I think it's a mistake to ascribe rationality to all human behavior. Beating your wife is irrational yet I understand it's not uncommon.
What the macroeconomists, like Bernanke, are trying to avoid in an incipient depression is a default spiral. They want to preserve economic activity; that is the most important thing. My conceptualization of what they are saying is to consider that maintenance is dependent on a velocity of money times the money available and the velocity is reduced in depressogenic conditions so to maintain anything like v(prior) x M(prior) with a reduced v(depression), they must increase M. They have mechanisms to reduce M when velocity picks up.
ALSADIUS: The "all else being equal" is critically important, not a pedantic detail.
I have no reason to doubt your economic credentials. That's another group who thinks that actually knowing the operational mechanics of how the financial system works is a "pedantic detail." Their cluelessness is obvious for all to see.
Every point that I made is true, by identity, or operational reality. But you need to know your way, at least rudimentarily, around a balance sheet to see it, and also rid yourself of gold standard thinking that the economics profession is mired in.
There is good documentation of how this works elsewhere:
nakedcapitalism DOT com/2009/10/the-choice-is-between-increasing-or-decreasing-aggregate-demand.html
MOSLEReconomics Dot com/mandatory-readings/soft-currency-economics/
nakedcapitalism DOT com/2009/10/all-debt-is-not-created-equal-government-debt-is-not-the-same-as-private-debt.html
Randall Wray, who I believe teaches at Bard also documents this pretty well.
"1) So the private sector cannot save on net unless the government is running a deficit? Hilariously untrue."
Not at all -- true by identity.
Net private savings is the paid-in equity line (assets - liability) on the balance sheet. If you understand accounting, go through t-table transactions at a non-Govt sector level and see how this can be increase as a whole. It cannot.
If you're a macroeconomist, you can derive it from the National Income Identity. Since you have an economics identity, I'll leave it to you to work out.
I'm not going to bother with the rest, you are not ready.
MDF: I am not wrong. I said savings accounted for investment *and* inventory. Cars piling up in Long Beach count as inventory, and it's pretty useless. We totally agree that savings is "dead money" and doesn't do anything, nevertheless it's how you account for unconsumed production, and says nothing about the value of what's been done with it.
I'd be careful, Winterspeak. I've been reading a lot recently about the dangers of concussions - you might be setting yourself up for a severe trouble later in life if you keep hitting your head against the wall like you do here...
Alsadius -
About taxation: your example assumes that the government simply taxes and burns the money, without replacing the demand. In a real economy, the government taxes to reduce demand in the private sector in order to "make room" for public spending. The reason this is different for a currency issuer than, say, a local government that needs to "fund" it's spending is that it is just as good for the private sector to save as to be taxed. In WWII, the government used both increased taxes and "war bond drives" to reduce demand enough to allow it direct 50% of output toward the war. The bonds were not needed to "finance the war" - they were there to prevent workers from spending their pay and bidding up prices. ((I would note that this accumulated savings, created by the deficits of the war, was a big driver of the postwar boom...)
JIMBARINO: You are a wise man. Alsadius' brand of vitriol, stubbornness, and wrongness is remarkable, and I have a fair amount of experience doing this sort of thing by now.
Then he revealed himself to have an econ degree, and all was made clear!
Saying "The government doesn't have to borrow or tax, it can just print" is like saying "The government can make eating food punishable by death". Yes, it's literally true, but anyone insisting on it as a way of making a point in a larger argument is a blind fool with no concept of reality. It will never happen, and it should never happen.
As for the gold standard, you're thinking of a different batch of economists. I've never liked the mysticism of the goldbugs, nor the idea that miners are better at monetary policy than economists.
As for the rest of your points, I'm wading through those articles you linked. Figure I might as well at least see what this philosophy of yours is in some more detail. It still feels like voodoo of the worst sort, the same sort of absolutism with minor details and neglect for larger issues that's been the root cause of a few other interesting but utterly pointless debates I've had in the past - the one that springs to mind best was a fellow who tried to convince me that the Titles of Nobility Amendment passed, and it means that lawyers are not citizens and thus cannot sit in Congress. Still, it's sort of been an interesting read so far.
"Saying "The government doesn't have to borrow or tax, it can just print" is like saying "The government can make eating food punishable by death". Yes, it's literally true, but anyone insisting on it as a way of making a point in a larger argument is a blind fool with no concept of reality. It will never happen, and it should never happen."
Hah! There's that pesky reality interfering with you again.
The Government prints money (literally, credits a reserve account) without taxing or borrowing every single day. Every. Single. Day.
You'll need to get into the gritty reality of a particularly obscure Government account (I think it's called something like that "tax reconciliation account") to see how this works operationally. G is driven by crediting accounts. T is driven by debiting accounts. Treasury bills move money from reserve accounts to Treasury accounts. G is not funded by T or "borrowing".
And while economists pride themselves on looking down at goldbugs, they are still living in a world for convertible, or fixed-fx currency, thus all the false beliefs about taxing in order to spend, govt debt being like private debt, etc. etc.
Glad that you've found the links a "sort of" interesting read!
The Government prints money (literally, credits a reserve account) without taxing or borrowing every single day. Every. Single. Day.
Of course. But not to finance its operations in any amount differing from what is taxed and borrowed.
You'll need to get into the gritty reality of a particularly obscure Government account (I think it's called something like that "tax reconciliation account") to see how this works operationally. G is driven by crediting accounts. T is driven by debiting accounts. Treasury bills move money from reserve accounts to Treasury accounts. G is not funded by T or "borrowing".
That would seem to be the Treasury Tax & Loan account. Not really so obscure at all, as it has about 14,000 institutional participants and processes all that, you know, tax money.
The TT&L account receives tax payments and holds tax receipts within the commercial banking system. So the tax money is kept in the banking system right along with all other kinds of deposits, and not "erased from existence" or any such thing.
When the Treasury has a bill to pay -- say $1,000 to Haliburton --- it makes a call on a TT&L account for the $1,000 which is then sent to the Treasury account at the Reserve bank, which then credits the Haliburton account at another commercial bank with the $1,000.
I suppose that in some abstract, philosophical sense, one could imagine the Reserve bank as creating, "printing" the money in the Haliburton account while simultaneously "destroying" the money taken from the TT&L commercial bank account. A sort of instant death-and-resurrection of money.
But as the two amounts are identical (the amount printed, "created", is limited to exactly the same amount simultaneously "destroyed"), and the net result is one commercial account credited by the amount another is debited, it's really a lot simpler to just consider it a transfer between the two accounts. Occam's Razor. The tax receipts account being charged to pay a government bill.
The TT&L has three explicit purposes: (1) To avoid flows of taxes directly into Reserve banks, which would be highly variable and play havoc with the reserve levels in the banking system, requiring offsetting open market operations, (2) to earn interest on tax deposits, and, not least (3) to provide the mechanism by which the govt's expenditures are paid with taxes, and not monetized by just printing money regardless of tax receipts (which, after all, is against federal law!).
"Glad that you've found the links a "sort of" interesting read!"
I don't know about Alsadius, but when I saw the name "Mosler" there it brought back happy memories of usenet a decade ago, good times, good times.
Warren and his horizontal demand curve for money ... Warren recalling how he was forced to explain the Paradox of Thrift to Larry Summers, who sat in incredulous silence through the whole presentation (which I don't doubt for a moment!)
Most useneteers who claim to refute all the world's great experts and practicing professionals on a given subject are just obnoxious, patronize-everybody cranks. But Warren was always very pleasant and enjoyable about it.
Of course the government creates money out of thin air(or wood pulp and ink, as the case may be). That's what fiat money is. The question isn't about the nature of fiat money, the question is whether it's practical to supply an unlimited amount of it out of nowhere in lieu of taxation or borrowing. You seem to be claiming that doing so is all fun and games, I claim that doing so is what causes hyperinflation and ruin. Given the data we have, I don't feel like I'm running much of a risk of being proven wrong.
JIM: Tax & Loan -- that is right! Good memory. There are a couple of academic papers that look at the timing of inflows and outflows and conclude that spending cannot possibly be funded by taxation.
In a fiat regime this is simply obvious to me, but I guess you need to keep the academics busy doing something! And looking at actual inflows and outflows is more useful than the nonsense they usually get up to.
The instant-death-and-resurrection is exactly the right way to think about. (And we are talking about the same Mosler! Highly recommend his site.)
The reason I like death-and-resurrection is because it gives a clear answer to the following question: what would happen if the Treasury just decided to stop issuing debt. So, the US would continue to run deficits, as it does not, but would no longer offer any t-bills etc. etc.
Alsadius would say this is impossible, and he'd be quite wrong. (Nice timing, Mosler has a good piece on his site by Goldman Sachs explaining that bank lending is not reserve constrained. Maybe he will believe GS since he does not believe me, or accounting : )
ALSADIUS: You have no idea what policy recommendation I have since I have not made any policy recommendation on in this thread. However, I have demonstrated that I actually know how all this stuff works, while you seem to alternate between saying "that's impossible" and "OK, it's possible, but it's trivial and I don't see the point". We are agreed that you do not see the point, so maybe our positions are not so far apart.
The US Govt never borrows money. As I just mentioned to Jim, think through what would happen if the Treasury decided to stop issuing debt, but the Govt continued to run deficits as it does now. Mervyn King explained this in a speech a few months ago when the UK was thinking of doing just this. I assure you, the Govt's ability to deficit spend would be unchanged.
Shirley you can't be suggesting we return to the '70's!?!
Hyperinflation won't happen because it would be foolish and unimaginable damaging for us to engage in it as a country. Pelosi, Reid, and Obama are running the county. Why am I not comforted by your argument?
To explain why I think the risks lie in the directions of fiscal crisis rather than hyperinflation, I turn to Tyler Cowen, who elegantly summed up the government's problem at a conference I attended last week: inflation only works on stocks of debts, not flows. You can inflate away the value of debt you've already issued, but especially in these modern times, bondholders will rapidly ratchet up the interest rate they charge...
And more than that, everybody seems to keep missing the blindingly obvious fact that the overwhelming bulk of the obligations the US can't afford are for *entitlements* -- which means they are explicitly inflation adjusted (Social Security, federal and military pensions) or effectively so (Medicare, as payable in real terms).
Thus, it makes no sense at all for the gov't to even think about "inflating" to get relief, because it would provide zero relief -- these obligations are un-inflate-awayable by their terms.
That leaves only these options: raise taxes in *real terms* sufficiently to pay the promised benefits, cut the benefits so taxes cover them in real terms , combination of both, or fiscal/political crisis -- keep the benefits as promised without providing the resources to pay them and watch the fun and games in the streets.
To this, my excellent former co-blogger Winterspeak responds that since the United States has a monopoly on the currency it issues, it can't default -- it can just keep running the printing presses.
As attractive as the "Weimar option" is on its own, and as fondly as the Germans remember it to this day for preventing default back when, it is useless for meeting obligations defined in an ever rising portion of GDP in real terms.
To meet transfer obligations defined in a rising portion of GDP one must tax a rising portion of GDP. As long as one can do so, fine.
But every society has a limit to the amount of taxation it can bear in real terms, for reasons both political and economic (such as the deadweight cost of taxes that rises by the *square* of the increase in the tax rate).
As that limit is approached, bad things happen all around -- to the value of the govt's debt and currency, and in domestic politics.
Even Weimar learned that. For all that it avoided default.
Please Jim -- where did I recommend any kind of Weimar option?
You make an excellent point about inflation adjusted obligations, they reduce the Govts ability to manage money, just like TIPs. If there are mechanisms in the US that might lead to hyperinflation they are TIPs, COLAs, and any mechanism that drives deficit spending during times of inflation. If unemployment insurance is an automatic stabalizer, then anything inflation adjusted is an automatic de-stabalizer. (Good thing CPI is a scam, right ; ) ) But hey -- why worry about real problems when we can flap about over data entry?
Taxation reduced aggregate demand, it does not fund anything. I don't see any excess of aggregate demand right now, and some would argue that there has been a chronic lack of it for several decades now (not a position I take, btw).
Also, Warren had a great example about our entitlements. Suppose you had 1 worker, and 300 million retirees. Is the problem with that situation whether or not you can tax the one worker enough so the 300 M retirees have the money they need to buy stuff? Would this problem be avoided if the deadweight loss from taxation was linear, and not to the *square*?! (Please, that was a joke, I know about the deadweight loss of taxes).
It's really interesting to me that to clearly see the split between real and nominal you need to fully embrace what is nominal at an accounting level.
Site's up now. GS article on the pointlessness of reserves (Alsadius -- pay attention!)
http://www.moslereconomics DOT com/2009/11/02/goldman-excess-reserves-irrelevant-and-the-fed-does-not-need-to-execute-reverse-repos-with-non-primary-dealers/
TheRaven is impressed with Megan's grasp of this and other subjects. Her $100k education debt for a mixed background in liberal arts and reality was both a good investment and yet another proof of fallacies buried in our national accounts. It must be a living irony to both grasp the definition of 'net worth' yet also prove the limitations of said definition.
TheRaven wonders whether Megan has read The Great Wave. David Hackett Fischer's long view of inflation is a sobering read. The inflation risk we're facing is not in current debt levels but rather in the collision of: (a) the beneficial effects of said debt (return to growth); (b) dwindling commodities; (c) one-third growth in world population over the next 40 years; (d) tripling the world's middle-class over the next 20 years. TheRaven points to pre-2008 commodity price spikes as obvious harbingers.
Fischer considers 20-40 years as piffle. The Great Wave chronicles 4 major bouts of global inflation over a 600 year period. Historic inflation rates were much lower than what we now accept as the low-end of an acceptable range. Yet inflation crept up on mighty governments and the historic end result was catastrophe.
(TheRaven having spoketh thus flew off to ask Jane Kaminsky how she writes performance reviews for one of America's greatest living historians)