Use access key #2 to skip to page content.

Follow up: What would happen if the US Federal Government stopped issuing bonds?

Recs

11

July 10, 2011 – Comments (17)

I got a few good commments on my other blog (here, here is the original Caps post: here) that allowed we to expand on some of my points. I think they are worth sharing

-----------------------------------

djp101 wrote

Madoff = bad
Treasury = Good

You may be correct and the problem could come when everybody agrees!

    
binve replied

djp,

>> Madoff = bad Treasury = Good

Maybe, but that is not an apt comparison.

Madoff is a currency user. He needed to finance his operation. And when it became unsustainable he needed new investors to pay the old ones. This is why his scheme was a Ponzi and why it fell apart. He was revenue constrained.

The US government is not. It can never run out of Dollars. It never has to decide to not pay one US Dollar obligation instead of another. It can always 'afford' to pay them all.

This does *not* mean that it should just create tons of money and start throwing it around. There is no nominal constraint to Government spending, but there is a real constraint. Namely there is only so much output and real resources that can be bought up. Government spending in excess of the real output of the economy results in inflation.

That is the limiting case (or should be the limiting case). I would argue that currently we have 9% unemployment and 36% underemployment, so right now we are not near any kind of inflation barrier. However, I would not take that point and just argue that we should advocate blind spending to stimulate aggregate demand either.

My point with this post is the the 'debt ceiling debate' is idiotic once you understand what the real constraints are. And once you do, we can have more productive and focused discussions on the economy.
    
djp101 wrote

Binve, It goes to the credibility of the system.  If you are correct, it does not make me apt to take on further risk as an economic participant.

    
binve replied

djp,

That is of course your call. My point of this post (and all my posts of these types) is to describe the system that we have.

Most people still try to use convertible currency economic models and analysis to describe our 100% fiat system, and that is completely incorrect. Still more people try to describe our system based on the Money Multiplier Model or the Quantity Theory of Money. Two completely flawed and inadequate models.

I am not trying to call our system 'good' or 'bad'. I am just trying to illuminate how it actually works so that we can have productive debates about not only our system, but the type of policies that our system can and cannot support.

Currently the mainstream thought supporting austerity is based on 'contractionary fiscal expansion' (i.e. That the government reduces it's deficits to avoid financial crowding out of private investment, thereby inducing/making room for an investment boom). Once you understand sectoral balances of the macroeconomy and you figure out that all of the 'finanical crowding out' arguments are garbage (based on the flawed 'loanable funds' theory), your realize that the logic behind this idea is incorrect.

Maybe one has ideas that we should have a smaller government on principle (and I certainly wouldn't argue against it). But if one argues for smaller government in the current environment (balance sheet recession) on the theory/justification that this will promote more private sector investment as most of the economic participants are paying down debt, then I call BS on that line of reasoning. It doesn't bear up to scrutiny. Because it doesn't jive at all with the system that we currently have. If we had a booming economy with high competition for resources, then a smaller government (i.e. smaller federal government deficits) would help the economy to keep inflation under control.

Most analysis and rhetoric boils down to: Federal deficits = bad and Federal surplus = good, without any consideration at all with what is happening in the other two sectors of the macroeconomy. And that is just bad analysis driven by nothing but ideology.

djp101 wrote

Binve, I appreciate all the work.  I have learned more here on the matter than anywhere else.  Even my banker cannot answer these questions.  In your opinion is there any checks and balances to the system you describe above?  Your reasoning seems logical, my only concern is that this system as describe is constantly miss-allocating resources to the point that it has become the problem with the economy.

    
binve replied

No prob, djp. I am just trying to share insights, and I am glad it is appreciated..

Re: Checks and Balances / Misallocation of resources

I think the biggest crime that has been perpetrated on the US economy over the last 3 decades is a two-parter:

1) Repeal of Glass-Steagall and the extreme deregulation of the financial industry that has allowed it to become a massive parasite that displaces productive work while extracting 'rents'. This is a massive (and persistent) Congressional failure that is getting progressively worse as the financial lobby becomes larger over time.

2) Complete faith in monetary policy as the main / exclusive tool of choice to create 'stability'. I discuss this in more detail here: http://caps.fool.com/Blogs/inflation-and-asset-price/592721

I think these are the biggest sources of loss of checks and balances / misallocation of resources in the economy today, and neither are a direct function of our currency system. Rather they stem from the mindset and ideology that has been prevalent in government.

I think we need people in Congress (and in the Treasury and Central Bank for that matter too) who actually understand how the monetary system operates. Who understand that fiscal policy (and tax policy) is a much more useful tool for generating productive growth (and quashing malinvestment) since it can be targeted, as opposed to monetary policy which is a blunt instrument and has different implications for savers vs. creditors. I am not talking about central planning, just smarter planning than the 'no planning'/'dumb planning' that we have now. I mean 'cash for clunkers'? That's the best we can come up with?

Breaking up big banks and reinstating Glass-Steagall would be the single biggest step in the right direction and then getting members into Congress who understand how our monetary system works is next. That would go a long way to restoring many of the checks and balances that are currently missing.

17 Comments – Post Your Own

#1) On July 10, 2011 at 4:50 PM, TigerPack1 (97.83) wrote:

This CAPS article written one year and seven months ago, still stands as the best way to "fix" the economic disaster that is unfolding in America: http://caps.fool.com/Blogs/how-to-fix-america/302070?&mrr=0.14

Our leaders have ignored every "suggestion" so far, including breaking up the large banks and eliminating the too big to fail problem that is rotting America to the core!

-TP

Report this comment
#2) On July 10, 2011 at 5:00 PM, awallejr (83.98) wrote:

Breaking up big banks and reinstating Glass-Steagall would be the single biggest step in the right direction and then getting members into Congress who understand how our monetary system works is next. That would go a long way to restoring many of the checks and balances that are currently missing.

I can't argue with that but, sadly, I don't see that happening.  If anything we've made the big banks bigger.

Report this comment
#3) On July 10, 2011 at 6:07 PM, Mega (99.96) wrote:

Your post is interesting, but I think your scenario is unlikely.  If Congress fails to reach an agreement on the debt ceiling, austerity measures will be chosen since they are legally and politically clearer.

If no one is talking about your idea, that probably means it's not going to happen.

Report this comment
#4) On July 10, 2011 at 7:31 PM, binve (< 20) wrote:

Quantemonics1,

I agree with your Reduce the size of individual Banks, and the Too Big to Fail conundrum. section.

awallejr ,

I know, that has been and continues to be an extremly disappointing failure.

MegaShort,

>>If no one is talking about your idea, that probably means it's not going to happen.

Yep. I am not holding my breath.

Report this comment
#5) On July 11, 2011 at 3:05 AM, NeilW wrote:

There's a slightly different view that you can take with the central bank. You can view the central bank as being the only one that is exempt from the legal capital constraints.

The Treasury is really only a currency user, but a special one in that it owns the central bank issuing the loans. Therefore any time the central bank issues a loan in favour of the Treasury it doesn't matter what the interest rate is since it is effectively zero (any interest charged comes back to the Treasury as profit - net result is zero or thereabouts).

The central bank is not going to ask for the money back (it doesn't need to, it is not capital constrained), nor is it going to write the loan off (the Treasury has confiscation powers after all).

Very soon you realise that the separation between the Treasury and the Central bank is completely artificial and that things make much more sense when the 'money destruction' powers of taxation are combined with the 'money creation' powers of a bank.

 

Report this comment
#6) On July 11, 2011 at 8:54 AM, binve (< 20) wrote:

NeilW ,

While I don't agree with all of the descriptions in your post, I certainly agree with all of the implications. See this previous post: http://caps.fool.com/Blogs/the-us-treasury-and-the/452537..

Report this comment
#7) On July 11, 2011 at 9:50 AM, PeteysTired (< 20) wrote:

Government spending in excess of the real output of the economy results in inflation.

How do you measure "real output"?

Report this comment
#8) On July 11, 2011 at 10:05 AM, binve (< 20) wrote:

PeteysTired,

That is a good question, one without a 'rigorous' (i.e. 100% deterministic) answer. It is an aggregate quantity, much like aggregate demand.

However when the economy is operating near its real output capacity the following condition will be true: resource utilization will be near 100%. Employment is a resource so by definition unemployment would be near zero. Also hard assets will be utilized which means there will be competition for them, putting upward pressure on prices => inflation starts to increase.

Therefore we can infer 'nearness' of approaching real output by looking at these other factors.

Report this comment
#9) On July 11, 2011 at 10:32 AM, PeteysTired (< 20) wrote:

If we had a booming economy with high competition for resources, then a smaller government (i.e. smaller federal government deficits) would help the economy to keep inflation under control.

So, it the opposite true?  We have a NON booming economy with low competion for resources, so a LARGER gov't would would help the econonomy to keep inflation under control?

Report this comment
#10) On July 11, 2011 at 10:39 AM, PeteysTired (< 20) wrote:

Sorry for all the questions, I am just a little slow :)

Why are we experiencing inflation when gov't spending has not EXCEEDED real output (resource utilization will be near 100%) of the economy? 

 

Report this comment
#11) On July 11, 2011 at 10:51 AM, binve (< 20) wrote:

PeteysTired ,

>>We have a NON booming economy with low competion for resources, so a LARGER gov't would would help the econonomy to keep inflation under control?

Almost.

We have a non-booming economy. Consumers are in a balance sheet recession. They are trying to pay down debt. Debt/income for the private domestic sector is >110%. So from a sectoral balance of the macreconomy, savings - investment by the private domestic sector will be larger of a very long time as that debt is being paid off. At the same time we continue to have a current account deficit. Exports minus imports (X-M) is a negative number.

The macroeconomy must balance:

(I – S) + (G – T) + (X – M) = 0, or rewritten:

(G-T) = (S-I) - (X-M).

This means that since S-I is positive (and will stay that way since the private domestic sector has a continued savings desire because they want to (NEED to) pay down debt accumulated during the last cycle of 2002-2007, and we have a current account deficit, then (S-I) - (X-M) is a positive quantity.

Which means that the Federal government must run a deficit (Govenment spending is greater than Government taxation, such that G-T > 0).

If the government does not do this, then either X-M will become less negative (which is highly unlikely, since we already have a manufacturing slump and an unemployment crisis, so how exactly will we raise exports). or much more likely the S in the S-I term will decrease. Consumers will stop saving.

Which means the private domestic sectors debt to income will not go down. Which means the condition of borrowers being underwater will not ameliorate. Which means that spending will not be sustained. Which means that prices will drop. => leads to likely deflation in prices.

I am not saying that is good, I am not saying that is bad. I am saying based on the sectoral balances of the macroeconomy and the current environments (balance sheet recession with a current account deficit), then that is the most likely outcome if the government proceeds along an austerity path.

This is the type of analysis that needs to be done in the mainstream, so that people discuss it in the right context. We need to have informed analysis and make informed decisions based on that analysis, not the ideological rhetoric that is currently passing for 'analysis' among mainstream economists and members of congress.

Report this comment
#12) On July 11, 2011 at 10:59 AM, binve (< 20) wrote:

PeteysTired,

>>Why are we experiencing inflation when gov't spending has not EXCEEDED real output (resource utilization will be near 100%) of the economy?

We have a very *uneven* inflationary environment right now.

Core inflation is not high at all, but food and energy (especially energy) is high. Why is that?

I am sure most people blame this on 'money printing' by the Fed ... Bull sh*t. If so, then why wouldn't we see more pronounced inflation across all components.

No, it is (primarily) because we are the most intensive energy user on the planet as well as the biggest energy importer. So we are subject to external supply and price setting issues.

We have energy price volatility and current 'inflation' (and we had extreme deflation in energy prices not even 3 years ago) because of exceptionally bad energy policy decisions over the last 30 years.

Report this comment
#13) On July 11, 2011 at 11:11 AM, Frankydontfailme (27.33) wrote:

Binve, wouldn't defaulting/ restructuring the debt quickly get us past this 'balance sheet' recession? 

Report this comment
#14) On July 11, 2011 at 11:27 AM, binve (< 20) wrote:

Frankydontfailme,

I don't know what the full outcome would be (other than very messy and dangerous).

First, it would be a complete and utter failure by Congress and mainstream economists. If we default, we will be saying to the world that "yes, we are indeed revenue contrained, we can't afford to service the debt and default is the best option". That is 100% categorically incorrect. It would be a triumph of ideology over analysis. (I am thinking like the Church forcing Galileo to recant his findings).

Again, I am not calling our system good or bad. In fact, maybe our 100% fiat currency system will fail before this period is done. But if it does so, I would like it to be because we as a nation understand it and decide that Nixon made a grave error in 1971. Not because we are applying old and inapplicable convertible currency economic models to our 100% fiat system and using that is a justification to determine that we are 'broke'.

That would be utterly and compleltely stupid and pathetic. It would be an economic failure of the highest degree.

So right now, there is no need whatsoever to default. Not need whatsoever to restructure.

But let's say mainstream economics does produce this 'epic fail' along with congressional ideology. What would happen?

You got me. There would be so many dislocations it wouldn't even be analyzeable. Because the US Government security repo market is *by far* the biggest on the planet. It dwarfs the stock market many times over. It dwarfs the size of most countries economies. And so if the US government decides to williingly default (possibily the stupidest decision our country would ever make) then that market would be in turmoil since no one could be sure their bonds would be honored.

It would be much better to be honest right now that the bonds don't fund anything and just gradually and consiously do away with the whole system like I talk about here: http://caps.fool.com/Blogs/what-would-happen-if-the-us/612372. Tell the American people the truth. Call out mainstream economics for the massive failure in recognizing this fact. And deal with the real issues (not this fake 'default' possibility issue) facing our nation..

Report this comment
#15) On July 11, 2011 at 11:43 AM, PeteysTired (< 20) wrote:

We have a very *uneven* inflationary environment right now.

Have we ever had an "even" inflationary environment?  I just don't understand and I don't mean to nitpick, but this statement is confusing to me...sigh.

If we had a booming economy with high competition for resources, then a smaller government (i.e. smaller federal government deficits) would help the economy to keep inflation under control.

We have soo much extra resource capacity right now I would think according to your comment above we would be defaltionary right now. It tells me that something else must be happening.  I agree about energy policies BTW, but I would have expected the recession to drop all prices across in every sector.  That clearly is not happening.  Home prices are the only thing I can measure that are going down and I am not buying a house.  Everything has stayed about the same and increased. 

Prior to the recession, my cable bill is more, grocery is more, dining is more, gas is about the same, movies are up, my rent is the same.  My contract wage went down from 2008.  All of this while unemployement and underemployment has grown.  I am just not getting it. 

Report this comment
#16) On July 11, 2011 at 11:45 AM, PeteysTired (< 20) wrote:

Prior to the recession, my cable bill is more

This should read "From just before the recession, my current cable bill is more, ......"

 

Report this comment
#17) On July 11, 2011 at 11:59 AM, binve (< 20) wrote:

PeteysTired ,

>>Have we ever had an "even" inflationary environment?  I just don't understand and I don't mean to nitpick, but this statement is confusing to me

It is what I said in comment #12

Core inflation is not high at all, but food and energy (especially energy) is high

'Inflation' is a composite metric. Besides food and energy, there is 'core'. Core inflation is another composite metric, made up of healthcare, apparel, housing, services, etc.

>>We have soo much extra resource capacity right now I would think according to your comment above we would be defaltionary right now. It tells me that something else must be happening..

Exactly, there is something else happening.

We have excess capacity. And then in 2007 the blance sheet recession starts in earnest. And if nothing else happened by the government we would have enterned an extremely deflationary depression.

But the automatic stabilizers kicked in (increase in welfare, social spending, unemployment benefits, etc. when people started getting laid off in droves). These happen 'automatically' (hence the name) as services are called upon by the private sector. Addtionally there was massive stimulus by the government in 2008-2009. This spending in excess of taxation (G-T) > 0, made up the shortfall in the economy so that the savings of the private domestic sector (S-I) could be maintained.

That is why pronounced deflation has not occured.

>>Prior to the recession, my cable bill is more, grocery is more, dining is more, gas is about the same, movies are up, my rent is the same.  My contract wage went down from 2008.  All of this while unemployement and underemployment has grown.

I can believe it. The other thing to realize is something I talked about here: http://caps.fool.com/Blogs/macro-thoughts-and/524129. Corporate margins are at a near all time high. They are trying to squeeze the consumer while the government is deficit spending (they are trying to do front running of the cycle). This is also because the PPI has been increasing for producers. But corporate profit margins are very mean reverting and likely the ability of passing on higher costs to consumers cannot be sustained as this balance sheet recession wears on..

Report this comment

Featured Broker Partners


Advertisement