US federal government shutdown threats by nihilistic politicians are now routine occurrences. Uncertainty over a looming ‘federal debt’ default chronically impeding US economic recovery, has nowadays become, a certainty. Washington now always waits until the last minute to raise the ‘debt ceiling’, which inflicts the greatest volatile impact to US markets and to US consumer confidence as possible. This is our present ‘Plan A’…
America can just continue to rinse and repeat Plan A, or, may I suggest, Plan B, which I call ‘Quantitative Redemption”: Announce that the $2 trillion of Treasury securities that were purchased during Large-Scale Asset purchases, a.k.a. Quantitative Easing (‘QE’), are now considered paid off (one arm of the federal gov’t sold IOUs, and another arm bought them back). Instead of continuing to keep these Treasury bonds ‘impounded’, or otherwise known as ‘held on the Fed’s balance sheet’, for a distant future ‘unwinding’ back into the secondary bond market (to brake a booming recovery that low rates should have caused), it has now been decided that due to economic conditions that are likely to remain sluggish for the foreseeable future, these securities are, effective immediately, considered “redeemed”. This action would have the same effect as if the FOMC Committee ceased maintaining its existing policy of rolling over maturing Treasury securities held on their balance sheet at auction, and instead announced that any maturing Treasury securities will not be rolled over, and also considered “redeemed”. Doing either of these would continue to accommodate the economy, the already loose monetary policy in place, because this actual decrease in Treasury bond supply would bid up prices in the bond market and pressure rates downward (and if done sooner, decrease the need for more doses of ‘QE’, or a ‘twist’, or endless Fed ‘jawboning’). This partial removal of federal ‘debt’ would put to rest any near-future ‘debt’ ceiling kabuki shows. Furthermore, this partial removal of federal ‘debt’ also removes that financial specter of federal ‘debt’ which would not only give Americans more confidence to spend, it would give fiscal policymakers more latitude to spend…
Treasury and Fed officials should then just level with themselves, level with the American people, and pivot away from the old, outdated, gold-standard-era beliefs that are no longer applicable in the post-gold-standard, modern monetary system. Educate the policymakers, and educate the citizenry, that since the gold standard era ended, the federal government is no longer subject, no longer constrained, to a gold-backed dollar currency, and now instead has full monopoly control of its own fiat dollar currency as the issuer. Explain to everyone how the federal gov’t used to have to first borrow someone else’s gold-backed dollars before deficit spending, but since August 15, 1971 there is no such thing as a gold-backed, gold-convertible, nor pegged dollar anymore, and now the federal gov’t just creates new fiat dollars whenever deficit spending. “Monetizing” debts of gold-backed dollars was replaced by “monetizing” deficits of fiat dollars. The federal gov’t can admit that it no longer needs to stick to the narrative that Treasury ‘debt’ issuance to ‘borrow’ fiat dollars is still needed to finance federal deficit spending. Congress still has to approve federal gov’t deficit spending just as during the gold standard era, but that is the only reason why Treasury bonds are issued today in the post-gold-standard era, to simply keep a running total of the amount of deficit spending, the amount of new cash that was created after being approved by Congress. Post-gold-standard era, the amount of new cash that is created by the federal gov’t is no longer a dangerous financial threat, but just an indicator, like a light on your car dashboard, that tells us how much new cash plus old cash (taken in by federal taxes) makes up the mix of dollars circulating throughout the economic ecology at any given point in time. If too high an amount of new cash is being created (the ‘federal budget’ has a large ‘deficit’), it just indicates that the economy is relying too heavily on the federal gov’t, so policymakers must immediately sync their fiscal and monetary policies to get growth going in the nonfederal gov’t. When re-calibrating these fiscal and monetary policy decisions to counter this low nonfederal gov’t aggregate demand, you are NOT trying to balance a gold-standard-era federal budget, but instead trying to balance a post-gold-standard era federal economy.
Treasury bonds today are no longer federal government debt like during the gold standard era because they are now denominated in fiat dollars, which are not backed by gold or fixed to anything, and these Treasury bonds are sold by the federal gov’t which is the issuer of these fiat dollars. The federal gov’t , the issuer of dollars, does not need to ‘borrow’ dollars from anyone anymore, and why buyers of Treasury securities today are not ‘lending’ dollars to the federal gov’t, but merely making a time deposit at the Fed, like buying a CD at any bank. In the gold standard era, when the federal gov’t deficit spent gold-backed dollars, it added to an outstanding float of national debt; post-gold-standard, when the federal gov’t deficit spends fiat dollars, these newly created dollars subtracts the purchasing power of the outstanding float of dollars. Finally, to quell the unnecessary fear over a ‘national debt’ that hasn’t actually existed since the gold standard era ended, the effort should be made to educate everyone exactly how federal government financing in the post-gold-standard, modern monetary system really works: During the gold standard era, the people’s surplus savings of gold-backed dollars financed the federal government’s deficit spending of gold-backed dollars; however, since then, it has reversed. Post-gold-standard, in the modern monetary system, the federal government’s deficit spending of fiat dollars finances the people’s surplus savings of fiat dollars.
Whether you are a devout follower of Modern Monetary Theory (MMT), or have never heard of it, I highly recommend ‘Understanding Government Finance’ by Brian Romanchuk, who is a Quebec-based fixed income quant analyst and publishes the website Bond Economics. Mr. Romanchuk’s expertise on the subject matter of government finance is evident, he has a B.Eng. in electrical engineering from McGill University, a Ph.D. from the University of Cambridge in control systems engineering, and is a CFA Charterholder. In May 2015, Brian Romanchuk was named by the Fixed Income Database newsletter as one of the ‘Top 10 Fixed Income Experts Worth Following’.
As per Mr. Romanchuk, the study of economic models, just like the study of mathematical models, includes understanding the rules, called constraints, that govern the behavior of variables in any highly complex system. These constraints affect the interrelationships of variables with all other entities within an economy, and understanding of these constraints (or the lack of constraints like a currency peg / gold fix) helps determine economic outcomes.
Mr. Romanchuk correctly takes aim at the pre-financial-crisis, US money market system, saying that it’s “negligible capital requirements exacerbated the crisis”, and generally “dragged US banks into the mess”. This is true. In ‘Stress Test’, written by former Treasury Secretary Timothy Geithner, US money markets were part of the tri-party repo market which seized when Lehman went bankrupt on September 15, 2008, magnifying the crisis. As a result of this interconnection and heavy reliance on the repo market for intra-day credit, the US Federal Reserve Bank’s macro-prudential policy today is to reduce the role of US money markets, broker-dealers, and clearing banks in the tri-party repo market.
In another clever observation, Mr. Romanchuk writes that US Treasury debt management officials have “painted themselves into an elaborate corner” by continuing to stick to the narrative that Treasury debt issuance is still needed to finance federal deficit spending, and that pure market forces alone determine the interest rates set at Treasury bond auctions (even though the gold standard era ended and the federal gov’t can now issue fiat dollars at will).
In ‘Understanding Government Finance’, Mr. Romanchuk wastes no time pointing out many of the common misconceptions by citizens regarding central government financing and the nonsensical tools used worldwide by monetary policymakers such as “counter-productive” US reserve requirements, “crazy” European negative interest rates, “meaningless” central government budget constraints, and “silly” Japanese quantitative easing. QE was first deployed in Japan in the 1990s and now practiced globally because central bankers yearn “to remain relevant after lowering policy rates to zero”, Mr. Romanchuk quips in yet another hits-it-on-the-head passage.
Book Review: The National Debit
The second edition was published in 2015, by Dog Ear Publishing. It is fairly slim, at 103 pages, and without a bibliography or endnotes. Given the target audience, the lack of a bibliography is reasonable, but it also limits the book for more advanced readers.
The book is focussed on the operational aspects of MMT: floating currencies, central bank operations, and the role of national debt. If there is a discussion of the Job Guarantee (which is an important aspect of MMT), I missed it. (The Job Guarantee is a programme where the central government guarantees a job for everyone, at what is the effective minimum wage. Since it requires working at a government-sanctioned workplace, it is distinct from “guaranteed income” schemes that are becoming popular amongst progressive activists.)
The author had a 30-year career in fixed income, working in New York and Tokyo. The historical analysis is generally centred on the United States economy, but he also works in examples from Japan. The book covers some of the recent areas of debate in the United States, such as Quantitative Easing and the debt ceiling.
I will not attempt to summarise the main points of the book within this review, but the main theme is that the mainstream fixation on the national debt is misplaced. Since Federal government debt is an asset of the “non-Federal Government” sector (private sector, foreign sector, state & local government), the “national debt clock” is really a measure of non-central government assets. Moreover, he suggests since government bonds are denominated in a unit of account that the Federal Government can create without using real resources, it is not really “debt,” in the same way that equity is not a “debt” of a corporation, since it can be freely issued. (But please note the debate around equity that I discuss here; Delzio may actually be out of step with the “official” MMT line on corporate equity.)
The National Debit is a straightforward read, particularly for those with experience in the financial markets. It focusses on the aspects of MMT that are of most interest for financial market participants, particularly for fixed income investors. The attraction of MMT is that offers explanations for bond market behaviour that are counter-intuitive from a “mainstream” point of view.
As someone who was in a similar position, this attractiveness cannot be understated. The mainstream approach to the bond market is hopelessly incoherent. Two contradictory views are simultaneously embraced.
- The markets are super efficient at discounting the future (rate expectations theory).
- The government bond market is priced based on an irrational fear of default. (The best course of action for bond holders is to roll over debt.)
I learned to ignore most economists’ views about interest rates; the only economists worth following had enough experience to unlearn whatever nonsense they were taught in university about interest rates. On the other hand, the MMT approach to “interest rate formation” is coherent, simple, and fits the facts on the ground. This is why there is a sub-culture of MMT enthusiasts within finance.(Austrian economics has a foothold in finance for a similar reason. Only a cloistered academic could believe that recessions are caused by fluctuations in productivity.)
Delzio gives a justification for the policy of continued 2% inflation; the idea is to punish hoarding behaviour. This runs right into the popular Austrian complaint about the U.S. dollar losing 97% of its purchasing power over time. It may have been useful to more directly take on the Austrian story, since it is a very popular factoid incorporated into many pieces of Austrian analysis.
Limitations Of The Book
The book does not attempt to cover the wider theoretical debates within economics, which erupt periodically across the internet. My ebook — Understanding Government Finance — covers similar ground, but I deliberately avoided making it purely an introduction to MMT. The reason being is that I find it somewhat difficult to distinguish MMT from the wider post-Keynesian school of thought.
In Marc Lavoie’s graduate text on post-Keynesian economics (reviewed here) covers the schools of thought within post-Keynesian economics. He sees underlying similarities, creating what he calls “broad tent” post-Keynesian thought. Modern Monetary Theory fits within that broad tent, with a coherent view on certain topics. What distinguishes MMT from others is the emphasis on monetary operations, as well as the embrace of free-floating currencies.
When I read the academic articles by MMT, they fit within that existing tradition. I assume that there are some arguments over who should be cited, but only an academic can really care about those disputes. (I write as a lapsed academic.) But the popular MMT works probably discuss the rest of post-Keynesian economics less than they should.
At the same time, not everyone is in agreement with Marc Lavoie about “broad tent post-Keynesianism.” There are “narrow tenters” who would dispute that MMT is actually post-Keynesian economics at all. There are petty academic disagreements, as well as more substantive disagreements about policy stance. (For example, a standard complaint is that MMT is “U.S.-centric” and “only works if you are the reserve currency.” This seems ridiculous; one of the “founders” of MMT — Bill Mitchell — is an Australian, and I am a Canadian. Neither the Australian nor Canadian dollar are reserve currencies, the last time I checked.)
If you want to get deeper into those sorts of arguments, you will need to find more advanced texts.
Even if you are not concerned about theoretical debates, it would have been nice to have some charts of economic and financial time series to illustrate points. Purely textual arguments are best buttressed if you can point to how they show up in real world data. For example, he cites the U.S. experience of U.S. fiscal surpluses being followed up by depressions/recessions. This is an argument that I would be cautious approaching. One could debate the U.S. experience about government surpluses. Moreover, Australia and Canada had Federal surpluses without perceived negative consequences.
Delzio follows the conventional line about the role of interest rates (that lower rates are stimulative for the economy), although he notes the MMT dissent about the effectiveness of Quantitative Easing. The belief that low interest rates are ineffective is not considered a “core belief” of MMT, even though Warren Mosler (one of the “founders”) advances the idea. Although an interesting area of debate, it was probably a good idea to avoid it as being too much for most readers to absorb at once.
The book is a good introduction to Modern Monetary Theory for the non-specialist reader, particularly those in finance. More advanced readers might find it useful to understand what are the perceived advantages of MMT with regards to understanding fiscal policy. However, it is not aimed at those who are interested in academic disputes.
(Brian Romanchuk IS A QUEBEC-BASED FIXED INCOME QUANT ANALYST WHO’S BEEN IN THE FIXED INCOME BUSINESS FOR MORE THAN A DECADE AND PUBLISHES THE WEBSITE BOND ECONOMICS…THANK YOU FOR THE REVIEW BRIAN, MUCH APPRECIATED!)
Hopefully in the not-too-distant future, prolonged zero interest rate policies (ZIRP) by central bankers along with stubborn sequestrations by politicians will be scoffed at as the financial equivalent of medieval blood-lettings…
Warren Mosler is right. The problem with ZIRP is that it has a deflationary bias. It has the same effect as a huge federal tax increase. By lowering overnight rates to practically zero, central bankers around the world are hoping that it will help the borrowers stimulate the economy at the expense of the savers. This is not printing money, it is a simple transfer of dollars from one group to another, dollars that are already in the money supply (what economists call ‘horizontal money’). This is effective over the short term because it lowers the cost, or interest rate, of capital by lowering the cost, or interest rates of fixed-income instruments like asset-backed securities derived from car loans or student loans, and mortgage-backed securities, plus other fixed-income like corporate bonds or municipal bonds (what everyone calls the ‘credit markets’)…
However, fixed-income instruments of the federal government like US Treasury bills, Treasury notes, and Treasury bonds are a different paradigm (what I call the ‘debit markets’), because unlike the issuers of fixed-income in the credit markets, the US federal government, the issuer of Treasury bonds, can also issue dollars. By lowering federal gov’t Treasury bond interest rates, you are lowering interest income that would have been paid by the federal gov’t into the money supply, into the economy (what economists call ‘vertical money’). This is beyond a mere transfer of horizontal dollars between borrowers and savers already in the money supply, this is an actual ‘vertical’ removal of dollars from entering the economy, just like a huge federal tax hike. In addition, making conditions worse, a federal spending sequestration, which also is a ‘vertical’ removal of dollars, kept from entering the economy, acts just like another large federal tax hike as well…
It is conventional wisdom today that all US Treasury bonds are ‘debt’. US Treasury bonds are issued by the federal government. US Treasury bonds are denominated in dollars. The federal gov’t is also the issuer of dollars. Dollars that, since 1971, are no longer convertible to gold and now freely float. In 1971, gold-backed dollars became fiat dollars. Therefore, since 1971, US Treasury bonds are not debt, and since 1971, there is no longer any such thing as a US national debt. In the post-gold-standard, modern monetary system, the federal gov’t, the issuer of fiat dollars, will never ‘run out’ of dollars. The federal gov’t, the issuer of dollars, doesn’t have to ‘get’ dollars from anyone. Nobody is ‘lending’ the federal gov’t, the issuer of dollars, anything. When Treasury bonds are bought, they are paid for with dollars, and those dollars are just deposits, just transfers, from one account at the Fed to another. The federal gov’t doesn’t have a limited ‘budget’ of dollars it can issue just like IBM doesn’t have a limited ‘budget’ of IBM shares it can issue. Everyone thinks that the federal gov’t needs to finance spending with federal taxes and federal gov’t borrowing as if we were still in the gold standard era, which allows the public to be exploited by many spreading fear about a federal debt that doesn’t actually exist…
It is also conventional wisdom today that all bonds including US Treasury bonds are part of the ‘credit markets’. However, there is a difference when someone that can issue fiat currency and deficit spends, from someone who cannot issue fiat currency and deficit spends. When the issuer of dollars deficit spends, the newly created dollars subtracts the purchasing power of their outstanding float of dollars. When anyone that cannot issue dollars deficit spends, it adds to their outstanding float of debt. Therefore, there is a difference between US Treasury bonds which are issued by the federal government which can issue dollars (‘debit markets’), from all other bonds which are issued by entities that cannot issue dollars (‘credit markets’). US Treasury bonds denominated in dollars that are issued by the federal gov’t that can also issue those dollars have no risk, are subject to managed Federal Reserve bank manipulation, and can never default unless intentionally done so by nihilistic politicians. All other bonds issued by those that cannot issue dollars have implied risk, are subject to pure market forces, and can suddenly default anytime. Wall Street ‘rate swap’ traders arbitrage the differences between the cost, or ‘fixed’ interest rate of risk-free capital in the ‘debit markets’, versus the cost, or ‘floating’ interest rate of riskier capital in the ‘credit markets’. Furthermore, economists can ascertain the condition of the economy by looking at the difference, or spread, of these rates. The wider these spreads, the bigger the stress that the economy is under…
The problem with the world economy right now is not that there is too much wealth in the hands of a few, but that by comparison, there is too little purchasing power in the hands of the many. Total aggregate demand, overall spending, or the economy itself, is out of balance. ZIRP is a disincentive for saving, but isn’t an incentive for spending, so ZIRP isn’t a cure-all. Aggressive monetary policy alone can’t get the economy in balance. To correct the imbalance in the economy, aggressive fiscal policy is also needed to increase consumer spending. To increase total aggregate demand, federal government policymakers need to increase federal gov’t deficit spending on public initiatives, public infrastructure, and public investments (fiscal policies) that causes transformations of new dollars going vertically into the economy to compliment the horizontal transfers of old dollars already there (monetary policies)…
Voters think that the federal government is the same as a household, that the household must not deficit spend too much, or else the household will get into more debt and the household budget will get more out of balance. Likewise, politicians refuse to consider more federal deficit spending because they believe it will increase the national ‘debt’, and the federal ‘budget’ will get more out of balance. Everyone has this backwards. Once the federal gov’t, the issuer of dollars, balances the economy, the federal ‘budget’ will move towards balance, not the other way around. Until the public and by extension, the country’s politicians, grasps this, stops their medieval thinking, the Fed, and also by extension, the world’s central bankers, have no choice but to keep saying: “More ZIRP” (or just like Steve Martin said in that classic Saturday Night Live parody: “More Bloodletting”).
eddie d <email@example.com>
NOTE: I may be off on all this (that monetary ‘stimulus’ is the equivalent of medieval bloodletting) by a thousand years. On 09/01/16, this post appeared on the Epsilon Theory website:
“Ancient societies without a causal explanation for, say, the weather, would construct some sort of combination of words and thoughts and actions to be performed by privileged caste members like priests or kings, through which the entire society convinces itself that humans can sometimes exercise some sort of control over an incredibly powerful real-world, and sometimes can not…
In fact, that’s the literal origin of the word “inexorable”, from the Latin in (not), ex (away), orare (to pray) — something that cannot be prayed away. In early days of any human society, this sort of magic usually emphasizes some form of sympathetic or like-for-like object … for example, you might rub a banana-shaped crocodile tooth against a banana plant to make it bear fruit (I’m not making this up). Over time, however, the spellcasting caste and society at large convince themselves that you don’t really need actual crocodile teeth, but you can instead invoke the power of a crocodile tooth by just calling it by its secret name, so you didn’t need to go out and hunt down a real-world crocodile. It’s at this point that hunter/soldier-kings are replaced by academic/priest-kings…
Want to see what a magic spell looks like? Here you go: This is the Gaussian Copula spell. It’s what you write down to make sure that your AAA-rated slice of a massive bunch of mortgages pays you 6% a year with only an infinitesimal risk of default. It’s not a metaphor for a spell. It is an actual magic spell, exactly the same in form and function as the talismanic scripts written on, say, Egyptian funerary urns in 1000 BC to make sure that your body and soul get to the afterlife with only an infinitesimal risk of default. Secret language no one can read or understand? Check. Not really comprehensible even by most magicians? Check. Administered by a privileged caste with appropriate pomp and ceremony? Check. Reflective of an innate human desire to control invisible forces that are, in fact, uncontrollable and inexorable, like death and business cycles? Check. Highly effective in motivating human behavior and supporting status quo political institutions? Check. And mate…
The magical thinking embedded in this spell is that a nationwide decline in U.S. home prices is not just unlikely, it is — literally — unthinkable. It is an incantation that generated enormous societal stability and wealth, creating out of whole cloth a belief that a $10 trillion (yes, that’s trillion with a T) asset class in residential mortgage backed securities (RMBS) was a solid thing, a triumph of Science (why, just look at all those Greek letters and the mathematical stuff!), an example of man’s mastery over the invisible vagaries of nature. And then we had a nationwide decline in U.S. home prices. Which broke our world. So what happened, we got another spell, we got the Taylor Rule spell. It’s what you write down to make sure that the inflation rate in your economy goes up or down the way you want it to go up or down. There are lots of other spells that go along with the Taylor Rule spell for “controlling” inflation, but it’s the main one, I’d say. This is the spell that has created a $12 trillion asset class in negative yielding sovereign debt. Because, you know, the lower interest rates go, the more you’re going to borrow and spend, and the higher inflation goes. Right? Right? If the Gaussian Copula is like a funerary spell, trying to assure investors that they will get to investor heaven like dead Egyptian Pharaohs were assured of getting to dead Egyptian Pharaoh heaven…
So what always happens, and I mean “always” in the sense of This. Is. Human. Nature. and has been happening in a rhyming sense for tens of thousands of years across every human society that ever lived, is this: In phase 1, the priest-kings try harder. They seek out purer ingredients for their spells. They speak more loudly, more convincingly, more stridently. If two crocodile teeth were used in the past, now they use four. Or eight. It’s not just “more”, it’s “MOAR!”. Often there’s an internal purge near the end of phase 1. In phase 2, the priest-kings regroup and tweak the spell. Maybe instead of “targeting” (another word for “praying for”) a 2% inflation rate, we need to “target” a 4% inflation rate. Maybe we should change the magic word “inflation” to “nominal GDP growth” and see if that works any better. Sure, why not? This tweaking process has happened, it is happening now, and it will happen all the way to the bitter end. What will never happen is that the priest-kings quit. There’s always another tweak, always another word choice, always another order in which the words can be said. In phase 3 — and this is where we are now in the historical process, somewhere near the end of phase 2 and the beginning of phase 3 — the priest-kings are challenged by a rogue priest in their midst (rare) or an alt-priest coming out of nowhere (common). By “nowhere” I mean that the alt-priest is an Other, whether that’s a foreign religion or a foreign geography or a foreign (i.e., non-priestly) caste. The alt-priest isn’t about tweaking the spell or casting it louder. He’s about doing an entirely different spell, and he’s about accusing the incumbent priests of incompetence or worse. The alt-priest is always a populist, and populism comes easy when the incumbent spells have been failing … and failing … and failing. So what happens? It depends on reality. It depends on whether the banana plants get better on their own or if they die. If they get better on their own (and this happens more often than you might think), then the incumbent priest-kings remain. If the banana plants give up the ghost, then the incumbents are swept away…
That’s why I want to pull my hair out when I watch the Jackson Hole theatre. Guys, you’re not helping! I was dumbfounded by the stultifying, excruciating more-of-the-sameness that came out of Jackson Hole. Oh my god, are we really saying that the entire FOMC decision-making process comes down to whether there’s a good jobs report on Friday? Why don’t we just inspect the entrails of a goat?
To riff on Woody Allen’s famous joke, we need the eggs. We need a stock market that goes up, not down. We need financial asset price inflation. We need the eggs so badly that we’re willing to support the magical thinking crew and smile at their courtiers even though we think they’re totally out of touch with reality. We’ve become so used to getting our eggs delivered on time and without fail that our first, second, and third responses are to ask for more magical thinking from the incumbent priest-kings, not less. This is a dangerous, myopic game. Because we will get what we ask for. We will get more magical thinking.
Maybe we’ll get lucky. Maybe the banana plants of global growth will turn green again. What I’m saying is that we need to think less about Scottish witchcraft, a la Macbeth and James Frazer and Stanley Fischer, and more about the Scottish Enlightenment, a la David Hume and Adam Smith and Alexander Hamilton. What I’m saying is that we need to focus on empiricism and on what works in the real world, not theory and what “works” as an equation. Let’s embrace and encourage THAT as we make our way through what is still a largely inexorable world.”
September 1, 2016