I know, I know, this falsehood has been skewered every which way from Sunday. But I couldn’t resist sharing one more.
I know, I know, this falsehood has been skewered every which way from Sunday. But I couldn’t resist sharing one more.
Are long-term government bonds a gift to bankers? Paying them interest to hold risk-free assets?
His key points, and my replies:
Whether or not you personally feel that taking on one type of risk versus another is worth being compensated for has little to do with whether a premium will exist for said risk.
Just because investors — mostly “bankers” in this market — inevitably demand a higher return for the reduced liquidity/”risk” of long bonds, does that mean that government should fulfill/supply that demand? “Tough luck. Hold dollars.” Would we have a more efficient market and more (widely) prosperous system, less distorted by Fed interest-rate machinations? It sure seems like it would remove one method whereby money moves to the top.
going full bore the other way and stating that issuance of long debt by the treasury is an intentional gift to the renter class is equally an act of logical absurdity.
“Intentional”? Je ne sais pas. I tend to wonder whether economists/financiers actually understand money economies well enough to engineer such a conspiracy. (And of course I tend to question conspiracy theories in general, given the general level of human incompetence.)
But that doesn’t mean that the bond-based system doesn’t have the effect that I and Galbraith describe, or that the winners in that system don’t actively or even frantically maintain it for that (semi-conscious?) reason.
there could be some other value to having long term default risk free debt obligations (to appropriately match assets and liabilities)
Yes, it’s possible that the dynamic system that exists with government bond issuance/manipulation/markets yields greater prosperity than a dollars-only system would. But:
1. Wider prosperity?
2. I don’t know if there’s any way we could know that, even via weather-system style dynamic modeling of the type that is, sadly, barely on the horizon in the economics dodge. (Interestingly, Steve Keen in his workmanlike, accounting-based approach, seems to be getting closer, faster, than the seemingly sophisticated Santa Fe Institute gang.)
I’m seeing a really close parallel here to the old “New Monetary Economics” that Tyler gets so gushy about. The NMEer’s notion is that we should eradicate government money, so the only money-like things are private financial instruments. Its stronger proponents claim that it would eradicate the business cycle! (Which I prefer to call the financial cycle.) I think they’re on the fully-loony end of the “free markets will solve everything” spectrum.
MMT is semi-opposite — government only issues dollars, no debt. Is it equally utopian? No, because:
1. It envisions management by government, rather than magical, Panglossian equilibrium via the markets. (See #3.)
2. It explicitly addresses the distribution issues that have been systematically excluded from neoclassical theorizing, which very issues might be the primary cause of financial cycles (at least the big ones, the long-term culminations).
3. Its proponents have enunciated a clear countercyclical automatic stabilizer policy to implement it that addresses the political problem of politicians implementing real-time discretionary fiscal policy: a guaranteed employment system. (The issue they haven’t solved, to my knowledge: what is the political method whereby the government employment wage is set?)
If the Modern Monetary Theory model is correct, does “government savings” (either a stock or a flow) mean anything? Is there any such thing?
According to MMT thinking, the government creates money into the private economy by spending (including via interest payments on bonds), and destroys money out of the private economy by taxing. (Bond issuance and
retirement reabsorption by the Fed is just interest-rate manipulation.)
Does a bowling alley have a stock of saved points?
Please tell me where I’m getting this wrong.
If the modern monetary theory folks are right, there’s no reason the government should be paying interest above inflation on bonds and bills. It’s an artifact of the gold standard, utterly unnecessary (and economically destructive) in a fiat-currency economy.
This realization courtesy of a February policy note by Jamie Galbraith that I just came across:
… how reasonable is it to assume a 3 percent real interest rate on US public debt? … it normally should not be so for a sovereign borrower who controls her own currency and therefore cannot default. … to an investor safety is valuable, and … under capitalism making money ought to require taking risk. There is no reason why a 100 percent–safe borrower should pay a positive real rate of return on a liquid borrowing!
The federal government doesn’t need to compensate for risk. It isn’t trying to kill off a high and intractable inflation. It also doesn’t need to lock in borrowing over time; it pays the higher rate on long bonds mainly as a gift to banks.4 Moreover, it controls both the short-term rate and the maturity structure of the public debt, and so can issue as much short debt at a near-zero rate as it needs to.
Average real returns on the public debt were in fact negative in 18 of 36 years from 1945 through 1980 (measuring against the realized inflation rate). They were slightly negative on average over that entire period … Today, with inflation low, consistently negative average real rates on all public debt are again possible, especially if the government stops propping up bank earnings by issuing long-term bonds.
Yes, bond investors face the risk that inflation will increase, and future returns will be negative. But how does that explain the issuance of Treasury Inflation-Protected Securities (TIPS), which guarantee a fixed rate above inflation — return with no risk? If savers want to earn a return above inflation, there are plenty of options out there — notably real assets, and the semi-real assets embodied in equities.
Yes, they all have risk. Quel dommage. If you want real returns, invest in something real.
While Galbraith doesn’t say it here, this leads inexorably back to the MMTers’ main point: there’s no reason for the government to issue debt; it could simply spend instead — issue zero-interest (dollar) bills instead of interest-bearing bills. Government bonds — and their use by the Fed to manipulate interest rates — are simply market distortions.
And that leads to the real aha! of Galbraith’s paper:
So long as interest rates exceed growth rates, any primary deficit is “unsustainable.”
Check out his graphs:
The government budget is on an “unsustainable” path for one reason only: because it issues bonds (especially long-term bonds, especially TIPS) — an ongoing gift to the banks.
Who benefits from those bonds? Financial arbitragers. Rentiers. With the active support of the Fed’s “open market” manipulations, they are a vehicle for funneling taxpayer dollars to the — literally — idle rich while sucking sustenance from the real economy. (In this case via interest payments using taxpayer dollars.)
Now: are you wondering where those “unsustainable deficits” are coming from?
The key graphic:
For those who don’t click on links that say “Source,” click here:
This is one of those graphics that speaks volumes about how right-wing economists are completely divorced from reality.
They point to the sun rising in the east and say, “You see? I told you sun rises in the west.”
Traders Crucible shows you the pictures:
And he runs the numbers:
I’m not making any grand statements here about how money economies work. But I’m making a pretty strong statement about how they don’t work. They don’t work the way freshwater economists say they do.
I know it’s hokey: “Make a DIN!” (Hat tip: Gerald Ford.)
Paul Krugman and others have been raising this issue front and center of late (notably today), which prompts me to post this, which I’ve been poking at for a while. I intended to make it much longer, with many more references, but I’ll give you what I’ve got.
If we want to rebalance and reinvigorate our economy, there is no better pathway than five or ten years with slightly higher inflation. Especially wage inflation.
• Transfer relative purchasing power (hence power) from holders of financial assets to holders of real assets — from Wall Street to Main Street.
• Spur both consumption spending and investment spending (on real assets) by individuals and businesses — driving our economy up to its full capacity and employment potential.
• Deflate the country’s massive overhang of under-collateralized business, personal, and government debt. (Debt that is not backed up by sufficient quantities of real assets.)
If managed properly, it could even result in wages rising as fast as prices (or even — pas possible! — faster) without the dangers of the bogeyman “wage-price” spiral (of which there is zero sign at this time).
First, understand this:
The reason we don’t have higher inflation — and why we’ve had such supposedly benign low inflation throughout the so-called Great Moderation — is because low inflation serves and protects the wealth of financial-asset holders, especially holders of bonds and other fixed-interest investments.*
This is the trillion-dollar gorilla in the room. Inflation immediately and permanently devalues the whole existing stock of financial assets — not just the comparatively measly annual flows in the real economy that economists tend to prattle on about, often on tenuous theoretical grounds.
With $60 trillion of domestically held financial assets out there (less than 20% of it in company stock/corporate equity), an extra percent of inflation cuts circa $600 billion each year from the buying power of financial-asset holders — from their ability to buy real assets, and to consume the products of those assets.
Among households, at least 87% of financial assets are held by the top 20%. The bottom 60% hold 4% of those assets. (These are conservative estimates.)
Is it any wonder that the financial powers that be — the fed, the treasury, the regulatory agencies, the leaders of the financial industry, and their many elected toadies — have so assiduously engineered low inflation for so many years? One can only wonder why they didn’t figure it out sooner.
Meanwhile, holders of real assets get the benefits of inflation. They can trade those inflated assets for more money/financial assets, and claim a larger piece of the production pie. Those who have borrowed to purchase real assets — risk-takers (choose your own moral valence) — receive even more benefit, because the can pay off their loans in less-valuable dollars. The relative value of their real assets increases, while the long-term (hence present-value) cost of those assets decreases. This includes, significantly, those who have equity in, and debt on, their residences.
“Real assets” don’t just include structures, equipment, and sofware — the “fixed assets” that are totted up in the NIPA tables. They include anything that produces real human value: knowledge and skills developed through education, training, and experience, “organizational capital” (arguably the bulk of most companies’ real value, what makes them “going concerns” — often labeled “good will” in company valuations), ideas and inventions, and a whole plethora of other intangibles and unmeasurables.
Your ability to work, even your enthusiasm or diligence, is a real asset. With higher inflation, you’ll be able to buy more financial assets for each hour you work. It’s only a relative gain (relative to current holders of financial assets), but that makes it no less real. It gives you a greater claim on a share of the real stuff out there.
Here’s another way of thinking about it: both real assets and financial assets represent claims on real production — buying power. The two together constitute the whole pool of claims. If you shrink the claims of financial assets via inflation, the whole pool shrinks, and the claims from real assets constitute a bigger part of the pie.
Another way to think of it: inflation is to financial assets what decay and obsolescence are to real assets.
If it weren’t for inflation, the rich really would own everything (instead of almost everything).
This immediate and permanent inflation effect on financial asset values — and hence, the shift in buying power from holders of financial assets to holders of real assets — is by far the largest, most immediate, and most permanent result of inflation. So what does the economic community have to say about it?
First, they tend to characterize it differently. Every economics textbook tells you that inflation effectively transfers value from creditors to debtors. This is certainly true; debtors get to pay off their loans in less-valuable dollars. But that characterization imparts a decidedly different moral tenor — not fully intentional by the authors, perhaps, but still very real: “savers” — those who put their money in financial assets, creditors — are good, while debtors are bad, and shouldn’t be rewarded by inflation.
This characterization is perfectly embodied in the whining by Carmen Reinhart and Bill Gross — fawningly telegraphed by Jeff Sommer in the New York Times — about “financial repression” of bondholders via low real interest rates. My heart bleeds.
The implicit moral narrative is very different if savers are “hoarders,” while purchasers and creators of real assets are “investors.” (It’s worth noting that Simon Kuznets, the man who in the 1930s created the system of national accounts now used in some form by every country in the world, characterized real capital — the stuff we use to create stuff in the future — as “the real savings of the nation.” Capital in the American Economy, p. 391.)
However that transfer is characterized, though, economists uniformly agree about inflation’s effect on the value of financial assets — certainly regarding fixed-interest assets. It’s pretty straightforward arithmetic.
They also generally agree that:
• At least in the long run, inflation has little effect except via its effect on assets. Incomes/wages and prices go up together on the rising tide of inflation. This is probably delusional for various reasons (certainly wages and prices can diverge for decades), but it’s generally accepted, and it’s certainly true in the (very) long run.
• Higher inflation causes people to spend (consumption and real investment) rather than saving/storing money in financial assets. Since a dollar tomorrow is worth less, it’s rational to spend it today and get more, rather than saving it and storing it in financial assets that decay with inflation. This “hot potato” scenario results in more transactions. And since the gains from trade — the “surpluses” created — are at the very heart of economic thinking, the increase in trade spurred by inflation (which is itself neutral, at least in the long term) is presumably A Good Thing.
Higher inflation would be quite similar in its effects to the financial assets tax that I proposed a while back, and carry the benefits I describe there.
* Corporate stock — equity — is something of a special case. Since its value is tied more directly to the value of the companies’ real assets — expressed as a share future returns generated from those assets — stock values presumably rise more readily with inflation.
But a stock certificate is not really “ownership” of a company’s assets — you can’t ask for your part of those assets, or control them in any way as you could with real assets that you own. Rather, it’s just a contract giving you quite limited legal claim on future returns generated form those real assets, and (in theory) some voting control over how those returns are generated and distributed.
Given the limitations on those legal claims and rights, the complex credit, debt, and international structures of most corporations, and the influence of “animal spirits” on equity prices (even over quite long periods), it’s not at all clear that one percent of extra inflation will result in stock prices rising commensurately. Any savvy financial investor looks at total equity returns, subtracts inflation, and derives “real” returns. From that perspective at least (though it’s perhaps misbegotten at least to some extent), inflation directly deflates the value of equities.
All that said, two things:
• If (people believe that) equity values do move with inflation, then higher inflation would discourage credit investments (bonds) in favor of equity investments, which like real assets, hedge against inflation. And equity investments are arguably a healthier form of investment for our economy as a whole.
• Don’t forget that equities comprise less than 20% of outstanding financial assets. Per the Wall Street wags, the stock market is the “retarded younger sibling” of the bond market. It’s where the “dumb money” lives. When it comes to transaction volumes, it’s chump change.
Update: I meant to add that most economists these days question the Fed’s ability to increase inflation via monetary policy. Which means that fiscal policy — what Abba Lerner called “functional finance” is the necessary tool.
Well at least that’s true of freshwater economists and their saltwater outliers (no names, just initials: Greg Mankiw).
Here’s how those economists think:
People are rational economic actors.
“Rational” means thinking like an economist.
Rational (read: freshwater) economists know that government spending is (deferred) taxation.
So when government spends, these rational people think and act as if they’re being taxed.
This thinking is so 1. circular and 2. ridiculously false on its face that it seems to need no rebuttal. But I will:
People also know (because they think rationally, like economists, and have perfect foresight) that future economic and population growth, productivity increases, and inflation will obviate (to some extent) the personal cost they’ll incur from those future taxes. (Assuming they even live long enough to pay them.)
But these economists don’t see that, because unlike people, they’re not rational: they don’t think like economists.