77 Deadly Innocent Misinterpretations (77 DIMs #50-56)

Deadly Innocent Misinterpretation #50: Every time that the Federal Reserve Bank pays interest on excess reserves, they are subsidizing the banks.

Fact: Every time that the Federal Reserve Bank pays interest on excess reserves, they are not subsidizing the banks.

“It’s a bit of a misnomer to think that there’s a subsidy there. We aren’t paying an interest that is above the general level of short term rates. We are paying rates to the banks that they can get from other banks or from elsewhere in the short-term money markets. In addition, those Treasury bonds and MBSs (our assets), are yielding much more than the interest we are paying on those reserves (our liabilities), so it is not a subsidy to the banks—and in fact it is a huge profit to the federal taxpayers.”—Fed Chair Jay Powell’s comment after the FOMC unanimously raised the target range for the federal funds rate to 1-1/2 to 1-3/4 percent, 03/21/2018

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Deadly Innocent Misinterpretation #51: The Labor Force Participation Rate remaining roughly unchanged is a sign that the job labor market is terrible because disenfranchised people have given up.

Fact: The Labor Force Participation Rate remaining roughly unchanged is not necessarily a sign that the job labor market is terrible because disenfranchised people have given up.

“The LFPR remaining roughly unchanged is actually another sign of improvement of the current strength of the labor force given the downward pressure of our aging population.”—Fed Chair Jay Powell’s comment after the FOMC unanimously raised the target range for the federal funds rate to 1-1/2 to 1-3/4 percent, 03/21/2018

“The recent year’s strengthening of our labor force participation has been an upside surprise that most people didn’t see coming and is extremely welcome.”—Fed Chair Jay Powell, FOMC Statement press conference, 03/20/2019

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Deadly Innocent Misinterpretation #52: The Fed is trying to fight inflation by creating unemployment.

Fact: The Fed is not trying to fight inflation by creating unemployment.

The Fed targets (the Fed sets) the overnight interest rate between banks (known as the Federal Funds Rate)—and adjusts that rate as it sees fit in order to (as mandated by Congress) maintain price stability and achieve MAXIMUM employment. The Fed also makes ‘predictions’ (known as the Summary of Economic Projections) of what the Fed’s committee guesses what the unemployment rate will be in the future. This ‘dot plot’ of projections is dangerously, innocently and fraudulently misunderstood by the entire MMT community as meaning that the Fed is ‘targeting the unemployment rate’ and ‘intentionally creating unemployment’.

Anyone (from the new MMT student all the way to the veteran MMT academic) who says that ‘the Fed is trying to fight inflation by creating unemployment’ during The Longest Jobs Growth And The Longest Economic Expansion In UNITED STATES HISTORY—many thanks to the Fed—is being a tad fantastical.

Anyone saying ‘the Fed is intentionally creating unemployment’ has no idea how out of touch they are with how capitalism works nor has any idea how ridiculous they sound. It’s understandable when ‘entertainers’ over the airwaves today (playing to a specific ‘audience’) create stories to fit an anti-Fed narrative (because the first rule of feeding a conspiracy theory is that you never let facts, math & data get in the way of a good story). However, it’s another thing when political ‘prescription’ MMTers make things up. The Fed is mandated by Congress. Do ideologically-extreme MMT ‘scholars’ who think that the Fed is ‘intentionally causing involuntary unemployment’ think that Congress is in on this conspiracy too?

By the way, ‘involuntary’ means ‘forced’. Think bread lines during the 1930s—people were forced to be unemployed because THERE WERE NO JOBS—and then think about today’s 7,000,000 JOLTS. Meaning that there are more than 7 million jobs available! Meanwhile MMTers (with PhDs in Econ) think it would be a good idea to address those 7,000,000 open jobs currently going unfilled with a $500B federal ‘job’ guarantee (to ‘create’ more ‘jobs’). If you think that’s probably a bad idea then you will be reprimanded for being worried about ‘how will we pay for it’ and that you need to #learnmmt.

Another ‘prescription’ MMT proposal is to take away the Fed’s power of adjusting the overnight interest rate (resulting in the Fed no longer having that tool at its disposal to immediately respond in the event of financial emergencies). Many voices of reason, including the central banker in Japan—the so-called ‘poster child’ of MMT—have let the world know what they think of that proposal (and of today’s radicalized version of MMT).

“To be fair, both sides of the spectrum love to hate the ‘mysterious’ Fed and blame it for everything that is wrong—including sunspots. The better the Fed gets at the job assigned to it by Congress the more they are hated by each side. Although I would really like to see the Fed stop assigning a number to maximum employment as the NAIRU does not exist or at least changes its address so often as to be useless as a policy indicator. I think if one reads between the lines, Fed Chair Powell is there, but openly saying the NAIRU is dead by a Fed Chair would likely be very jarring to markets. I know the Chair of Economic Advisors Larry Kudlow has said the Phillips Curve which underlies the NAIRU is dead.”—Charles ‘Kondy’ Kondak

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Deadly Innocent Misinterpretation #53: Higher rates = higher interest payments to the economy.

Fact: Higher rates = higher interest payments to the bondholders (to the top 5% of the economy).

In a 03/06/19 discussion on Twitter, a comment by Monetary Wonk (@monetarywonk) that “MMTers want a permanent ZIRP [want to anchor the overnight fed funds rate to 0%] because they believe that Treasury [bond] rates are net neutral and don’t influence [aggregate] demand,” got this reply from Warren Mosler:

“No, the private sector credit is nominally ‘net neutral’ regarding non gov interest paid and earned, but the Treasury and fed—the gov sector—are net payers of interest to the economy. Higher rates = higher interest payments to the economy.”

Meaning that whenever you or I deficit spend (whenever the non federal gov’t creates money), that is an actual debt (for users of dollars), which is intended to be paid back (‘net-out’); so Mr. Mosler is correctly pointing out that it isn’t the case when the federal gov’t deficit spends (whenever the issuer of dollars creates money), since the federal gov’t is a ‘net payer’ because that money creation, is a net addition of dollar-denominated assets aka Net Financial Assets being added into the banking system, that is not intended to be paid back (to ever ‘net-out’).

That money creation by federal gov’t deficit spending is a stimulus to the economy. The reason why Fed Chair Eccles coined federal gov’t money creation ‘High Powered Money’ is because unlike federal gov’t surplus spending that DOES NOT add NFAs (which has a deflationary bias); federal gov’t deficit spending DOES add NFAs (which has an inflationary bias).

However, it is a bit of a stretch to also say that higher interest rates are a stimulus to the economy in the same way that more federal gov’t deficit spending is since (as the logic goes) ‘higher interest rates = higher interest payments to the economy’. According to this logic, the Fed is mistaken because it thinks that rate hikes are effective at slowing the economy—and therefore ‘the fed has the pedals backwards’.

That logic would be correct if most Americans were bond holders (if most were savers and only a few were borrowers), but in reality the opposite is true (making that logic seem ‘backwards’).

When the Fed raises rates, only the top 5%—the savers—are receiving higher interest; while the 95%—the borrowers—are paying higher interest to service debt +/or to deficit spend any further.

That’s why when the Fed sees too much inflation coming, they raise rates (a ‘net neutral’ dollar drain from borrowers to savers) as a disincentive to the 95%; and conversely, when the Fed sees too little inflation coming, they lower rates (a ‘net neutral’ dollar drain from savers to borrowers) as an incentive to the 95%.

“A change in money prices and money income does have ‘real effects’. If you increase the cost of money, that is a cost for debtors and an income source for creditors. This is real. By making debtors worse off and making creditors better off, there will be changes in the distribution of income, there will be changes in demand and in output. Real magnitudes in the economy will change.”—Steve Keen, ‘Can We Avoid Another Financial Crisis?’, 2017

Furthermore, when fiscal policy makers are not in agreement (like during a Republican ‘sequester’ or when Democrats are being ‘obstructionists’), the Federal Reserve Bank and their monetary policy makers become, as Mohamed El Erian put it in his book, ‘The Only Game In Town’. Meaning that monetary policy may not the best tool to stimulate the economy (and why so many are always critical of the Fed), but in absence of action from fiscal policy makers—when time is of the essence—the Fed becomes the Policymaker Of Last Resort.

With all due respect, anyone calling for taking those price-stabilizing abilities away from central bankers; or calling for a federal job guarantee program which takes employment decisions out of the hands of the private sector; or saying back in early 2016 that “it looks like the Fed began liftoff during a recession” may be the ones getting it backwards.

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Deadly Innocent Misinterpretation #54: A monetarily sovereign gov’t can issue all the bonds that it needs in its own local currency without the worry of default risk.

Fact: Even if issued by a monetary sovereign and denominated in their own local currency, there is still a default risk of bonds.

“It is a complete fallacy that a gov’t with monetary sovereignty can issue all the bonds that it needs in local currency without worry of default risk. It is also untrue that because you are a monetarily sovereign gov’t (that because you have the monopoly of issuing the currency) you can issue all the money that you want to finance deficit spending without risk of high inflation. The reason why a gov’t, that is monetarily sovereign, issues bonds (adds debt) that is denominated in a foreign currency—rather than in its own local currency—is not because they don’t understand MMT. It’s because there’s no longer any real demand for their own local currency. If an investor knows that a gov’t will continuously depreciate the currency (if an investor knows that a gov’t thinks it can create its own bonds without risk of default and create its own currency without risk of hyperinflation), then that investor will simply not want that local currency either. The reason why citizens nor investors don’t want their own local currency—the reason why they reject it—is because they don’t want to suffer the currency risk. There is evidence of more than 20 defaults of bonds denominated in local currency of gov’t with monetary sovereignty since the 1960s. In addition, throughout history there are more than 150 cases of fiat currencies, that because of high inflation, have disappeared—and in none of those cases did that gov’t decide to stop creating more currency (or issuing more bonds).”—Daniel Lacalle

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Deadly Innocent Misinterpretation #55: US Treasury bond coupon rates are not determined by market forces, they are instead set by the Treasury.

Fact: All US Treasury bond coupon rates are determined by market forces at origination.

A post on the Intro to MMT page on Facebook by Jim Gaddis (author of the book ‘Richard Gatlin and the Confederate Defense of Eastern North Carolina’) posed the question whether or not federal gov’t bond coupons were ‘set’ by the Treasury prior to auction or ‘set’ by market forces during the auction.

That was an excellent question.

The answer is both.

The Treasury used to set the coupon rate of all new bonds by an explicit pronouncement but that all got changed in the ’51 Accord. Now the market sets the coupon rate. It’s a ‘dutch’ auction for newly-issued Treasury securities. That’s where the highest bidder—the lowest interest rate (the lowest yield) that the bidder is willing to receive—gets filled first, then the next highest and etc, etc, until all the bonds are sold. The coupon becomes the average of all the yields accepted, rounded down to the nearest eighths of a percentage point.  

Anyone can go to the TreasuryDirect.gov website and after clicking the ‘upcoming auctions’ tab, they can see the ‘announcement’ (the details) of all marketable US Treasury bonds that are about to be sold to the public.

The coupon of any newly-issued Treasury bond is quote “to be determined” unquote during the auction (meaning whatever the market will bear).

There is an exception.

The coupon may however, be ‘set’, before the auction, but ONLY in the case that a Treasury bond is being ‘re-issued’ (aka ‘re-opened’).

If you look at the announcement details of a re-issued Treasury bond, the COUPON is already ‘set’ because the Treasury bond already exists and the YIELD (the final price that buyers will pay) for that additional batch is quote “to be determined’ unquote based on prevailing market yields. For example, if at origination (at initial offering) a 10-year Treasury note gets a 3% coupon (determined by market forces) and then the following month it is re-opened; if prevailing rates have dropped to 2.5%, then buyers of that batch will pay a premium because of that ‘set’ 3% coupon. In other words, the price that the investors will pay (the effective yield of that batch) is going to be in the neighborhood of 2.5% (determined by market forces).

The reason why the Treasury offers more of the same bond for sale is because federal gov’t deficits are rising, so they are increasing the frequency of bond sales. For example, the 10-year Treasury note usually is offered every 3 months. If deficits are rising quickly, the Treasury will re-issue that same 10-yr note the following month (technically as a 9-yr 11-month note auction).

If deficits keep rising, we may even see the Treasury bring back the issuance of the 4yr note or the 7yr note or maybe even the 20yr bond again (meaning less ‘re-openings’ of existing bonds needed).

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Deadly Innocent Misinterpretation #56: When a Non-bank (a ‘non formal bank’) lends EXISTING money to a borrower, it is NOT a credit creation. Only when a Bank (a ‘formal or traditional bank’) lends newly-created money is it a credit creation.

Fact: ALL borrowing is a credit creation (an expansion denominated in dollars).

“While Non-banks grant credit, it would be misleading to speak of ‘credit creation’ by Non-banks.”—Richard Werner, German economist, ‘International Review of Financial Analysis’, Volume 36, Pages 71-77, December 2014 (Mr. Werner earned a BSc at the London School of Economics. Further studies at Oxford University were interrupted by a year studying at the University of Tokyo—Japan’s most prestigious university—after which his doctorate in economics was conferred by Oxford. In Tokyo he was also a Visiting Researcher at the Institute for Monetary and Economic Studies at the Bank of Japan; plus he was a Visiting Scholar at the Institute for Monetary and Fiscal Studies at Japan’s Ministry of Finance. Mr. Werner coined the term ‘quantitative easing’. As chief economist of Jardine Fleming Securities Asia he used this expression during presentations to institutional clients in Tokyo in 1994).

He wrote that because when the Non-Bank (short for ‘non-formal bank’ like a shadow bank) is lending (which by UK law must always—only—lend with existing money), the Non-Bank gives up the same amount of their cash (-$100) in exchange for the same amount of the borrower’s IOU (+$100).

Thus, as this logic goes, since there is no change in the Non-Bank lender’s balance-sheet totals at the end of the day then that means there’s no credit creation.

(Speaking of being ‘misleading’, what about the borrower’s balance sheet that expanded—that went up from $0 to +$100)?

Perhaps, in Mr. Werner’s view, when the opposite happens, when formal banks that are lending with newly-created money, that is a different (read: lower) ‘hierarchy’ of borrowing. He calls newly-created bank deposits ‘fictitious’ and ‘imaginary’. That implies that he thinks only a loan using already-existing money is ‘sound’. Which is an ‘unsound’ argument because it makes no difference whether any money that was lent out was either newly-created or already-existing—because it mostly has to do with the ‘soundness’ of the person the money was lent to.

“They [AMI & ‘positive money’ folks] are wrong because as Minsky argued—and my models demonstrate—crises can still occur even if all lending was entirely ‘responsible’, meaning it was for productive purposes.”—Steve Keen, ‘Can We Avoid Another Financial Crisis?’, 2017

As per Mr. Werner, it is only when lending is done using newly-created money is it a ‘credit creation’. Apparently, if just lending with already-existing money, that’s totally different, that’s not extending credit, that’s not credit-creation, that’s ‘fronting’ someone money (or something like that).

Which completely ignores the fact that when someone gives you cash out of their pocket for you to borrow, not only do you the borrower receive an asset, so does the lender—and THAT’S the expansion, that’s the creation (of credit). The lender receives a NEWLY-CREATED IOU that goes in the lender’s pocket. Even if there is no actual IOU written out and handed over—if it is just ‘fictitious’ and ‘imaginary’—rest assured, that IOU is a real and potent thing because it’s a damsel named Faith (hooking up with a stud called Creditworthiness).

The only difference is that, unlike a credit creation using already-existing money, a credit creation using newly-created dollars involves a middleman (an underwriter). Whether funded by newly-created money or not, it is that promise to pay back the money with interest, it’s that newly-created IOU, that ‘bond’—that you conjured up out of thin air—that makes ALL borrowing a credit creation. The added account receivable, that asset, that credit creation, is always happening with any bond issuance, with any borrowing—with any extension of credit. When you pay the money back (when you put the bond in the ‘shredder’), that is the destruction. Those bonds being newly-created and newly-destroyed expand and contract the balance sheets. This leveraging v. deleveraging is the ‘beating heart’ and understanding that allows you to feel the ‘pulse’ of the economy.

Since the days of credit creation using tally sticks in medieval England, the lender’s faith in the borrower’s ability to pay back the money is a pillar of the economy. That’s why even to this day, a fiat dollar bill which is not backed by gold is still very valuable and why we say it’s backed by the full faith and credit—because it’s backed by the full faith and credit of the person who printed that piece of paper.

When it comes to borrowing in the private sector, it is WE who ‘print’ that bond, not the Bank and not the Non-Bank—they are only facilitating YOUR ‘printing’ of credit (represented by your newly-created bond). For example, VISA doesn’t contact you to let you know when they’re ready for you to go out to eat and pay on credit; and VISA doesn’t tell you whether to make the minimum monthly-balance payment, or tell you to pay the balance in full and destroy the credit creation—it’s the other way around. Anyone saying that credit creation is ‘only in the case of when borrowing newly-created money’ is missing the bigger picture. When someone lends, it is a granting of purchasing power—no matter if it involves any actual banks or any actual newly-created money or not. Whether banks are involved, or whether newly-created money is created or isn’t created, that is only a subset of the credit-creation process. As Dr. Steve Keen correctly wrote in his 2017 book, “credit is equivalent to the growth in private debt”. Meaning that EVERY time someone borrows, they are increasing private-sector debt (they are ALWAYS expanding private-sector balance sheets).

“Is Minsky (1986) right and ‘everyone can issue money'”?—Richard Werner

That’s close. Everyone can issue (can extend) credit. In other words, everyone can grant purchasing power and all borrowing by everyone is a credit creation (an expansion denominated in dollars). To believe otherwise is fictitious and imaginary.

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