Thursday, February 13, 2014

Preventing Crises

If since the USA was founded they had required banks to sell 10 year bonds to get the cash to use for 10 year loans (banks can't use demand deposits, must have matched duration bonds and loans, so no fractional reserve banking or "bank made money") and never went off a gold/silver coin money (no paper money or central bank) then I think that there would not have been anywhere near the number of inflations/booms/busts/deflations/financial-crises between then and now. If regular banks and central banks can increase or decrease the money supply, then the money supply is not stable, and you get booms and busts and crisis after crisis.

This is sort of my version of the Austrian Business Cycle Theory.   I think it is easier to think about in terms of central bank made money and private bank made money not being stable, so nothing is.   Fractional reserve banking is the core cause of financial crises and the reason people think they need a central bank to act as a lender of last resort.   If you did not have fractional reserve banking, then you would not need a central bank and could have a much more stable money supply and financial system.

For more than 2,000 years an ounce of gold has been about the value of a nice suit, shoes, and belt.   This is amazing stability.  The median life expectancy for defunct paper currencies is only 15 years.   Even in the big stable countries paper money loses more than 90% of its value in under 100 years.  In the 1950s a silver dime was about the value of a gallon of gas and 1/10th of an ounce of silver is still around the value of a gallon of gas but the US dollar does not buy anywhere near as much gas it could 60 years ago.  Paper money does not come close to the stability of gold and silver.  Paper money and fractional reserve banking together is a recipe for financial disaster.

Keynesians think that if we just make more money we could avoid the pain of the bust.  However, this can lead to hyperinflation and far more pain.   I think it is much better to understand the cause for the boom and bust and how to avoid these.   

This post comes from a conversation with Tom that deserves its own post and thread.

130 comments:

  1. Vincent I think you know my objection to this kind of argument by now:

    "For more than 2,000 years an ounce of gold has been about the value of a nice suit, shoes, and belt. This is amazing stability. The median life expectancy for defunct paper currencies is only 15 years. Even in the big stable countries paper money loses more than 90% of its value in under 100 years. In the 1950s a silver dime was about the value of a gallon of gas and 1/10th of an ounce of silver is still around the value of a gallon of gas but the US dollar does not buy anywhere near as much gas it could 60 years ago."

    1. Long term (1000s of years) average stability doesn't matter nearly as much as short term (human lifespan down to hourly) volatility.

    2. Arguing about how the value of the dollar has declined says nothing about it's properties in avoiding volatility. And talking about how much an oz of gold or a silver dime buys at two ends of a significant interval of time tells you nothing about it's volatility in between.

    3. Even a low inflation rate is still an exponential... thus given enough years you can bring up statistics to try and scare people ("Why back in my great great great great great grandpa's day, you could eat a good meal for a penny!")... statements like don't mean much... when I hear people making them I know they're trying to play on the emotions of those that don't understand math: even a 1% a year constant inflation rate will produce alarming changes in value given enough time because it's an exponential! The important thing is, how did that penny do in terms of avoiding volatility over your lifetime. And more important than that even, is how did it do in terms of avoiding volatility (away from trend) in NGDP = AD level growth. Volatility in the MOA combined w/ sticky wages & prices are what cause us to deviate from the Say's Law ideal of a barter economy, and result in harmful unnecessary real effects on the economy. It's not a cure all: there will always be real ups and downs even in a barter economy, but why choose an MOA that's going to exacerbate that?

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    1. In my point 3. above, I should have written "alarming changes in prices given enough time" not "value."

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  2. "Keynesians think that if we just make more money we could avoid the pain of the bust."

    First of all, it's not just "make more money" and it's not just "Keynesians."

    Sure, most monetarists (Market and otherwise) and Keynesians advocate a low to moderate STABLE trend positive growth in either inflation (inflation targeting, or IT), or NGDP levels (NGDPLT). But they are also aware (as was Milton Friedman, the famous monetarist), that you shouldn't undershoot or overshoot the target... so it's not true that these folks always just want to "make more money." Also, nominal shocks can occur in either direction: excess demand shocks to the MOA tend to result in recessions and disinflation (and sometimes depressions and deflation), and uncompensated shocks in the opposite direction tend to result in above target inflation rates. Neither are good! No Keynesians or monetarists think the cure to the latter is to "make more money."

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  3. I like what Cullen had to say here:
    http://pragcap.com/forums/topic/cullen-whats-that-thing-you-always-say

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  4. Some thoughts on what "Keynesian" means:
    http://mainlymacro.blogspot.com/2014/02/speaking-as-old-new-keynesian.html
    http://uneasymoney.com/2014/02/13/what-does-keynesian-mean/

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  5. I left a note for you on Nick's site, but it's worth reposting here: this from Lars Christensen, an MMist:

    "However, in Real Business Cycle models money are assumed to always be neutral – both in the short and the long run. I fundamentally think that is completely crazy and all empirical evidence is telling us that money is certainly not neutral i the short-run. Keynesian and monetarists (and even Austrians) agree on that, but the Real Business Cycle theorists do not agree. They basically think that recessions are a result of people suddenly wanting take have very long vacations (ok, that is not what they are saying, but it is fun…)

    PS As I have stressed before all the different models of the business cycle are basically about different assumptions about the monetary policy rule. Hence, we would in fact be in something, which looked like a Real Business Cycle world if the central bank targets nominal GDP. So if the central bank had got it “perfectly right” then Prescott would have been sort of right, but we of course know that central banks tend to get it horribly wrong."

    http://marketmonetarist.com/2014/01/29/the-awkward-moment-when-george-selgin-realized-he-agree-with-paul-krugman/

    Lars also has a series of posts on Argentina and other emerging markets:

    http://marketmonetarist.com/category/argentina/


    So Vincent, it trying to figure out where you fit on the spectrum of beliefs, you don't deny sticky wages & prices, from what I can tell. Nor do you deny the logic of what happens when sticky wages & prices combine with volatility in the demand for the MOA. So I guess that makes you quite different from old-Classicals and RBCers and even some Austrians. What you do seem to deny is that gold would be a volatile MOA if we followed your advice. Am I correct in my analysis of your beliefs? You're OK w/ sticky wages & prices and the concept that stickiness combined with a volatile MOA causes trouble: the part you just don't accept is that gold would be volatile if we made it the MOA and also followed your other recommendations. I.e. if we followed your recommendations gold would become perfectly stable in value, and we'd have no more problems with shock induced recessions and unexpected inflations.

    You go on to say there'd be no more booms or busts. I don't know of anybody that thinks that... even folks that believe in RBC or Say's Law, or at least folks that believe that Say's Law or RBC can be made to appear as if they are true.

    As far as I know, most people believe that business cycles do exist even in barter economies (i.e. outside of recessions and above trend inflations caused by nominal shocks). So I don't know how to categorize you there.

    Also you tend to return to this idea of going back in time and re-doing it all, except this time following your advice. You've written that several times now... usually when I ask you "So Vincent, if we follow your advice gold loses all volatility then? And what does 'we' mean: the whole world, or just one country?" ... so I'm not sure why you go back in time like this. Is it because you're saying we'd need to to make things right? That what we have now is beyond fixing?

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    1. Tom, if you read through my 38 year cycle thing to the right each time it is fractional reserve banking or printing money that causes the crisis.

      Sometimes I have said that if the reserver currencies all hyperinflate then all central bank reserves, except gold and silver, will become worthless and we will effectively have gold and silver backing again. So I can imagine a way that we transition to gold and silver backing for currencies. So while it is sort of beyond human planned fixing, the market could snap the world onto gold backed currencies at any time.

      Because prices do tend to be sticky, if the money is gold then the value of gold becomes much more sticky than it is now. The volatility of the value of gold would be way down if gold was what all the sticky prices were denominated in.

      The spin I would put on Cullen is, the real economy was still able to grow most of the time in spite of unstable money supply. That is not true in Argentina or Venezuela at this time. It is not even really true for wages in the US for the last 14 years.

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  6. Let me just break it down to be absolutely clear:

    1. Do you believe that wages & prices can be sticky?

    2. If we assume that theoretically, for the sake of argument, that demand for MOAs can be volatile, do you agree that this volatility combined with sticky wages & prices can cause recessions, depressions and unexpectedly high inflations (regardless of rules concerning banks, FRB or CBs)?

    3. Do you believe it's possible for there to be potentially harmful volatility in the demand for an MOA?

    4. Do you believe that the value of gold is currently volatile, and specifically too volatile to make it a good MOA (assuming, for the sake of argument, it's volatility would NOT be altered if we adopted your changes, or that we made it the MOA w/o adopting all your changes)?

    5. Do you believe that if we adopted your recommendations now that the volatility of gold will be attenuated to the point that it would make a good candidate for the MOA?

    6. In order for 5. to be true, what does "we" consist of? The whole world? Most of the world? Just the US? The US + some other important nations? A collection of important nations, but not necessarily including the US? Any country acting in isolation?

    7. Is it too late to adopt your recommendations? Would we have needed to start using your recommendations centuries ago? If true, who is "we" (as in question 6. above)?

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    1. I believe the harmful volatility in the demand for money has been because of volatility in the value due to fractional reserve bank made money and central bank made money. Look at my 38 year cycle page.

      4) Wrong. I believe that after the reserve currencies get hyperinflation any paper money left standing will only have value due to the gold reserves at the central bank issuing that currency. Effectively the market will put the world back on a gold standard. After this gold will seem much more stable than the time since 1973. I believe that much of the seeming volatility of gold since 1973 is really the volatility of the dollar.

      I don't think there is any chance that the world "adopts a gold standard". It will be the market making paper reserves worthless so that the only remaining reserves backing any paper money will be gold.

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    2. MOA has nothing to do with banks. When banks issue credit, that's MOE but not MOA. MOA is what the UOA defines a dollar in terms of. Banks could be outlawed entirely, and you could still have an MOA, and one that's potentially too volatile. Bitcoin could be made the MOA for example. Sometimes the MOA and the MOE are the same thing, but often they are not. My story on the last post about chickens and ducks didn't involve banks or a central bank at all: it was meant to demonstrate how a recession can result from a shock to the valuation of the MOA alone. Any commodity could be selected as the MOA: copper, corn, natural gas, oil. Or it might not be a commodity at all.

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    3. "I don't think there is any chance that the world "adopts a gold standard". It will be the market making paper reserves worthless so that the only remaining reserves backing any paper money will be gold.'

      It sounds like you think we're on the correct path then.

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    4. 1. 2. and 3. were just "Yes/No" questions.
      5. could be one too, especially if we edit it like this:

      5. Do you believe that if we adopted your recommendations now that the gold will be an acceptably low volatility MOA?

      I'll suppose you'd answer "yes" to 1, 2, 3, and 5. Or are you protesting that they are not really "yes/no" type questions.

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  7. Vincent, I read some of your 38 year thing. This caught my eye:

    "This would have been a 3rd period of hyperinflation in American history. Along with the Revolution and Civil War, with between 70 and 80 year spacing. If the US gets hyperinflation in the next few years it should really count as America's 4th hyperinflation, with similar spacing."

    ... and if we don't get it, then whoever is maintaining your blog 70 or 80 years from now will be writing:

    "If we do get hyperinflation in the next few years, we should really count it as the 5th hyperinflation, because it should have happened two other times in the past according to my theory." Lol

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    1. The only reason the US Central Bank did not go bankrupt is the government made it illegal for people to own gold. They did not have enough gold to pay off the notes and people were turning in the notes for gold. It was like a peg they could not maintain.

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    2. You saw my "Ponzi Gold Standard" post, right?

      http://howfiatdies.blogspot.com/2010/11/feds-ponzi-gold-standard.html

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    3. "The only reason the US Central Bank did not go bankrupt is the government made it illegal for people to own gold."

      Hmmm, sounds like a smart and worthwhile move on the gov's part then. Well done gov! :D

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  8. That 38 year thing makes a lot of statements that I'm highly skeptical of: ones in which you assert to know the cause for one thing or the next, but I think it's fair to say your conclusions are highly controversial. I'd LOVE to see Sadowski take some time and go through the whole thing in great detail. You should offer him a job to do so... he could weed out your weak statements. You'd be stronger for it. :D

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    1. What I would like to see is any financial crisis where fractional reserve banking (short term deposits lent out long term) or money printing were not implicated. Do you know of any?

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    2. So Yellen agrees that the Fed's low interest rates push up asset prices. It seems clear to me that in the housing bubble the low interest rates from the Fed's money printing are implicated as a big part of the problem. Sure there are other factors. But if we can not find a single case of a financial crisis that did not have central bank made money or bank made money leading up to it, it seems reasonable to claim that the key factor in laying the groundwork for a financial crisis is making money and a bubble ahead of time.

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    3. I'm not an economic historian. I'd suggest asking the following people:
      David Glasner
      JP Koning
      Mark Sadowski
      That fact that these people make themselves available to take questions from the public is a fantastic free resource. Go for it! I'd be very interested in what all three of them had to say on the subject.

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    4. One thought that occurs to me though (again, this is pure speculation on my part and shouldn't be taken to seriously)... I'd want to ask them about the places & times when the flexibility in the money stock (either MOA or MOE) was low: what was economic growth like at those times? My suspicion is that those cases tended to corresponded to places & times of very low growth.

      And don't forget that ancient and medieval times were more flexible than you may think: tally sticks and other forms of credit were used when coins were rare. Coins themselves were often clipped or shaved... and it's the clipped coins that were more likely to serve the role as an MOE (Gresham's Law). And the state itself was often the entity which debased the coins from the start (perhaps a smart reaction to a lack of the pure metals). Plus there were the 1000s of years of civilization preceding the invention of coins (coins were invented between 600 to 300 BCE). And there was a long period of time in Europe after the fall of Rome in which coins were not readily available. David Graeber documents much of this history in his book (which I did read). One of his main points is that barter was used, but was relatively rare: not something that was used on a daily basis. It was used in trade with foreigners basically (in the 1000s years prior to the invention of coins, and in modern primitive societies). Thus a natural flexible system based on credit was used in day to day transactions. Civilizations precisely quantized the credit (recorded on the clay tablets of Sumer, for example), while more primitive societies has a less precise way of recording it (the so called "Gift economies").

      You might be able to contact David Graeber too: try writing him an email. He was happy to take a lot of questions on Bob Murphy's site at one time... in fact he wrote so much there it was like reading a short book on the subject. Murphy collected his comments into a single post.

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    5. JP Koning has a very interesting blog post up on Somalia. He describes how their central bank literally came to an end, and thus all printing of their paper money stopped (I don't think it was replaced with electronic money either, Ha!). The gov script continued to circulate though as a form of money, but it eventually began to wear out so various warlords have taken to counterfeiting obvious fakes... but nonetheless the fakes circulate as money! It's an interesting story worth looking up. JP actually has written posts on many interesting historical examples as well as interesting current economies in the world (usually in an attempt to explore a concept such as MOE or MOA more fully).

      But in general I think the evidence is clear that no matter how many gun toting jack booted government thug bureaucrats people such as yourself would love to have running around stomping out private credit creation, it often turns out that ingenious people and dynamic economies usually find a way around these harsh statist inflexible authoritarian rules and regulations. So in spite of the control-freak authoritarians' best efforts, economic development still manages to occur. :D

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    6. ... but seriously, I wouldn't be surprised if the historical record showed an inverse correlation between long term economic growth and inflexibility in the money supply. Of course I don't know if that's true!

      Somebody pointed out in a Sumner post yesterday that there are lots of people, from Steve Keen to Richard Koo (I'd add Mish Shedlock), who've latched onto Irving Fischer's famous concept of "debt deflation" but they seem to focus on the "debt" part w/o paying appropriate attention to the "deflation" part of it.

      It could be that something like NGDPLT and MMism is a noble attempt to add stability to a flexible money system, thus preserving the advantages of flexible money, while mitigating some of the disadvantages.

      Going back to the gold standard with no flexibility in the creation of MOE to me seems like trying to go back to horse drawn carriages in an effort to cut down on highway deaths. It might be good for a post-apocalyptic world... but other than that...

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    7. ... but I guess that's what you're really saying isn't it: the world will see the wisdom of your system sometime AFTER a global financial meltdown (and probably WWIII)... when people will be overjoyed to own a horse drawn carriage or to have a gold coin to clip. :D

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    8. ... or more likely, have a small fragment clipped from a gold coin. Actually I just worked it out, if we divide up the world's gold equally, it comes out to 24.4 grams per person, or about 0.86 oz.

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    9. Re: Koning, Glasner & Sadowski... none of them will try to sell you anything either (when they give your their opinion), which is refreshing. People who are implicitly marketing their product by whipping up fear, I have little regard for. Which is why I like you Vincent! You're trying to convince us to be afraid, but other than your "donate" button at the top, you're not actually peddling anything. I commend you for that! :D (however, I suspect you've got a stockpile of gold somewhere, so I don't think your motives are entirely innocent... if you've got any more than 0.86 oz, then you know you're already ahead of the game... in our post WWIII future) :D

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  9. re: housing bubble: you should really read Sumner's latest post on that:

    http://www.themoneyillusion.com/?p=26140

    I'd read about Steve Keen's walk of shame on that before... a fun story. And I'm not saying I agree 100% with Sumner here, but I think he has a strong point. I think he could replace "Steve Keen" in the title with "Peter Schiff" and make a similar post. In fact it's already happened for Schiff... but will it happen again. Well they say a broken clock is right twice a day...

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    1. ... Steve Keen's walk of shame: I commend Steve for that too BTW. You'll notice in the comments, I think all econ types should be subject to that kind of humiliation as a matter of standard operating procedure. That'd make me feel better about the whole profession: if at any moment I knew dozens of them were taking long treks with signs around their necks saying "Ask me how I got it so wrong." What are the chances that someone like Schiff would ever admit he's wrong (much less agree to a 225km trek wearing a T-shirt proclaiming him to be so)? Pretty much 0% don't you think? Maybe Sumner (and Krugman!) are the same... I don't know. But Schiff's livelihood depends on him projecting an air of confidence at all times... he can't blink even once while boldly making proclamations into the TV camera... you should look up his debate with Sumner on youtube... I think it was CBNC. There's a world of difference in delivery... Schiff is obviously aware that he's selling confidence, while Sumner is "shifty eyed" in comparison. Funny, my gut is tuned 180 degrees out of phase with Schiff's usual victim, uh, I mean customer in that regard. My gut check tells me he's actually the shifty one!

      Yeah, I know there's no real value in what my gut tells me... but I have to tell you that's part of the reason I have a negative reaction to Schiff. I implicitly don't like or trust people whom I can't imagine ever admitting that they are wrong. His same msg delivered more humbly would help sell me on it. Maybe I just have a weakness for a different style of confidence man! Ha!

      Maybe you know of a clip of Schiff admitting he was wrong about something... my regard for him would actually tick up a notch if I saw something like that. :D

      Also there's a pretty good (and much longer!) youtube debate between Schiff and Roger Farmer that's worth watching. They get into a lot more detail. To me it's clear that Farmer absolutely destroys him... but maybe I'm just reacting to my gut's bias again. I'm pretty sure you'd have a different reaction.

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    2. ... while the above accurately represents my thoughts, I will say this: I wouldn't be surprised at all if our greatest thinkers (in science, math, engineering, etc) turned out to also be our most arrogant thinkers. Have you read "Surely You're Joking Mr. Feynman" ... if you have you'll know what I'm talking about. So I'm willing to admit my gut might be 100% wrong!

      BTW, in terms of people selling me stuff, especially investments, I'm MUCH more susceptible to a John Bogle type. That guy could really con the s*** out of me if he wanted!

      https://www.youtube.com/results?search_query=john+bogle&sm=3

      You probably wouldn't like him, because, like Sumner, he's implicitly an EMH guy (thus I doubt he'd say we can predict, much less identify so called "bubbles").

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    3. Schiff is an investor on fundamentals and his investment time horizon is much longer than most people, which is why they think he's wrong a lot of the time. If your investing with a 3-5 year time frame, then, yes, Schiff is going to be wrong for you when it comes to investing. If your time horizon is 15-20 years, then Schiff will probably be more right than he is wrong. Think of all the people that have said: "See, QE didn't cause inflation." Well, the problem with that statement is that QE hasn't caused inflation...YET. But it will. That is economic law. In fact, the whole point of QE is to buy more time to keep the party going. And it will go on for a bit longer because of QE. But how much longer? When will the party finally stop? When it does stop, it'll be due to rising consumer good prices. And when that happens, the peasants get restless, and things get ugly. Read Mises on the Crack up Boom. He says that the the crisis brought about by credit expansion (housing bubble) can be brought about later, rather than sooner, if more credit expansion is introduced (QE and ZIRP) So the question is not if the inflation will come, but when. And to that question, no one really knows. If they did, they would be a very well prepared and wealthy person. All we know is that due to QE, the crisis will come later, rather than sooner, and when it arrives, it will be in the form of the U.S. dollar losing its purchasing power very rapidly.

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    4. Neil,

      Well if the crises comes so late so as to never come at all (for me or my great great great great grandchildren), then I'm OK with that. In fact I wouldn't call that "postponing the inevitable" I'd call it "good monetary policy."

      Compare and contrast Schiff with Bogle: Bogle is all about long term investing too, but I have more confidence in Bogle's approach, and in fact I've been using it since 1990 with generally good results.

      I just think that Schiff appeals to pessimists. Sure he's going to be **partly** right again sometime! If you predict "bad, bad, bad, bad" all the time, then yes, eventually some bad will happen. And whatever bad it is, I'm sure Schiff will scramble to take credit for predicting it, even if it's 180 degrees out of phase with the particular kind of bad he was hoping for ...er... I mean, dispassionately projecting.

      Bogle says effectively "You probably can't outsmart the markets, so don't try. It's all about asset allocation given your time horizon. Good will happen, bad will happen. Position yourself to rides the ups and downs as best you can and don't over think it." Above all, don't try to time to market: odds are very much against you if you do.

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    5. ... Sumner explores a similar idea with doom and gloom economist Steve Keen here:

      http://www.themoneyillusion.com/?p=26140

      And BTW, if QE does result in a moderate amount of increased inflation, then that's basically what they were hoping for! One way to look at it is that the current rate structure doesn't work when everything's mashed up against the zero lower bound (ZLB) like it is now. In general we expect cash rates (nominal 0% by definition) < deposit rates < inflation rates < lending rates. The nominal rates don't matter: all that matters are the real rates (i.e. the rates after you subtract off inflation from the nominal rates). But even though that's absolutely true, psychology nonetheless comes into play.

      And because the 0% nominal rate is always an option (with physical cash available) then that puts a hard lower bound on the rate structure. If we were cashless (all electronic) or cash could float in relation to bank deposits and Fed deposits (not strictly a 1:1 exchange rate), then there'd be more flexibility in what rates could be, and it would be easy and workable for the CB to target a 0% inflation rate. But if that happened (say in the cashless society case) then people would be up in arms because their bank deposits would most likely be earning a rate < 0%. They would likewise not be pleased with an exchange rate that wasn't fixed at 1:1 for cash.

      Miles Kimball explores these ideas in some detail.

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    6. ... and regarding QE resulting in higher inflation because "it's an economic law" ... well in addition to that being the desired outcome (by a couple of percentage points, at least temporarily), it's by NO means an economic law.

      Vincent is fond of saying that the excess reserves could "leak out" as cash at any time... well despite the obvious problem there that this would require a huge [unexplained] uptick in the demand for cash from the public, it also requires co-operation from the Fed in ordering (from the BEP) and making available to the banks large quantities of new paper reserve notes. If the Fed doesn't do that, then it won't happen. I used to think that the Fed would never allow ATMs to go dry, but actually, that's very much a possibility (in some kind of bizarre spike in the demand for cash).

      Secondly, the Fed can instantaneously raise the reserve requirement to anything they want. For example they could raise it to 167% tomorrow and effectively eliminate all excess reserves (turning them into required reserves) instantaneously (1.67 = reserves / checkable-deposits = $2.5T / $1.5T). ... and at 167% I hope we'd hear the last of the complaints about so called "fractional reserve banking" ... funny how those complaints always assume the fraction <= 1, when in fact it certainly doesn't have to be!

      And BTW, once the reserve requirement is set to 167%, then the Fed will have no problem using pre-2008 style OMOs to set the federal funds rate (FFR) or overnight rate to anything it wants to above the interest of reserves (IOR) rate (and with similarly small amounts of repos and reverse repos!). And in fact they could then return the IOR rate to 0% without any further expense or distress to the Fed, all while not attempting to unwind the Fed's balance sheet (i.e. sell off Tsy and MBS assets) at all!

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    7. Tom, in some sense the electronic dollars are backed by paper dollars. If the Fed stopped making paper dollars for the banks, and the banks could not let people take out paper dollars when the had electronic dollars, it would seem to the general population that the banks were bankrupt. The value of paper dollars and electronic dollars would diverge if they did not convert as fast as people wanted. You would get sellers saying, "we only take paper dollars", or things like "our price in electronic dollars is 20% more". But also, people would just flee dollars and the value would go down. It would not go well.

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    8. Vincent, I'm conflicted about the paper dollars argument. I don't believe that they necessarily "back" electronic dollars (as you say). For one thing, there's not nearly enough of them. On the other hand I'm sympathetic to the concept that letting ATMs run dry is a bad idea. However, I don't think it'd have to come to that. Businesses would probably much rather deal in electronic money than paper. Banks certainly would (they'd love to get rid of those costly ATMs).

      Also, if everybody wanted to withdraw their deposits as cash at once, this really does represent a big problem: Why would this happen? I can think of one reason: say the Fed instituted a negative IOR rate... the banks would then have to charge depositors for the their deposits (rather than pay them) and this would drive people into cash.

      One way to solve that problem (though I have no idea about the laws on this) would be to let cash float against deposits (with deposits being more valuable). That was one of Miles' ideas... thus reducing the attractiveness of withdrawing cash.

      I'm sure steps could be taken to prevent the mass withdrawal: it wouldn't be good in general.

      But still reserves exceed deposits by about $1T. That means that even if all the deposits were withdrawn, then there'd still be $1T left over that the banks would not want to convert to vault cash because vault cash does not earn IOR.

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    9. ... and because businesses and banks would rather deal in electronic money than paper or coins, they'd be in a position to offer a reward for that to customers.

      Ultimately, I wonder if it wouldn't be possible some day to outsource printing of paper money to individuals: if you want to withdraw $100 in cash, then print it yourself. Then the story instantly prints up your change on the spot. It has some kind of unique bar code on it, and businesses/individuals(w/ smart phones) can instantly check that it's not "counterfeit."

      The banks would LOVE to ditch all those expensive tellers and ATM machines (plus the Brinks trucks and armed guards servicing them).

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  10. Here's an old one from Sumner in which he goes over a little history (between WWI and WWII, specifically the run up to the GD and the first few years of it):

    http://www.themoneyillusion.com/?p=3316

    I think the name "market monetarist" had not yet been invented.

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    1. You'll notice that both Sumner & Glasner (Glasner in a comment) criticize Hayek's Austrian masochistic initial embrace of deflation... but Glasner points out that later on Hayek admitted he was mistaken about that (I think I might like this Hayek fellow more than I first thought :)

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    2. I asked Sadowski what might cause him to doubt MM: he didn't answer the way I would have liked (imagining new evidence that might come to light in the future) but he basically used it as an opportunity to demonstrate pro-MM evidence:

      "Tom Brown,
      For starters, what if the following things weren't true?"

      He then gives a long (for a blog comment... even compared to mine!) summary of evidence for MM, including some interesting historical tidbits that I'd bet contradict what you hear from non-Hayek type Austrians. I'd be interested in your reactions...

      http://diaryofarepublicanhater.blogspot.com/2014/02/ben-bernanke-proves-sumners-wrong-about.html?showComment=1392522337032#c7994232829032945412

      I'll highlight one specific piece of evidence he gives early on about the Great Depression:

      "2) The initial recovery from the Great Depression under FDR was swift. Real GDP growth averaged 9.4% a year from 1933-37 and unemployment dropped from 20.6% to 9.1%. And we know based on analysis by E. Cary Brown, Christina Romer, Barry Eichengreen etc. that the contribution of fiscal policy to the recovery was minor. Thus this was primarily a monetary policy led recovery."

      He goes on to elaborate with more specific evidence about the GD. Enjoy! (Sadowski always plays a strong game... that's why I'm so eager to see somebody go up against him in that regard... I love a good fight!... sadly most people either fold or put up a weak argument)

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    3. ... and then he looks at the UK in the GD:

      "3) The UK adopted a zero interest rate policy in 1929. Uemployment rose from 8.0% to 16.4% by 1931. In September 1931 the UK abandoned the gold standard which enabled monetary stimulus. Britain was able to leave ZIRP by 1934. GDP expanded by 23.0% between 1931 and 1937 and unemployment fell to 8.5%."

      He elaborates on this further down in the comment.

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  11. Banks are usually at the center of financial crisis because they are at the center of finance. But it doesn't follow that if banks were made safe, you wouldn't have the crisis. Because the risks would move to other firms, doing the same things as banks, even though technically not banks. It's really hard (perhaps impossible) to design regulations that make the system as a whole safer. How do you force people through regulation to be prudent, not act in herds, not extrapolate past returns, etc? (Keeping in mind that regulators are subject to the same biases as the people they are regulating!)

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    1. Max, more and more I tend to agree with your view. Honestly I don't think there's a practical way to tell for certain, but I find the mainstream explanation for recessions fairly compelling (i.e. recessions are caused by an excess demand for the MOA). This view has nothing to do with banks.

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  12. Vincent, I happened upon a conversation between TravisV (one of Sumner's long time commenters) and James Caton (whom I only just heard of, commenting on Glasner's blog and leaving a link to his own blog). Caton sounds like a real scholar, and he responded with some links to his own scholarly papers on the subject when TravisV asked Sumner's readers for information on why the gold standard failed between WWI and WWII. This is a gold mine of info for you!

    http://www.themoneyillusion.com/?p=26186#comment-318847

    http://www.themoneyillusion.com/?p=26186#comment-318851

    You're welcome!

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    1. Seriously though, this James Caton guy looks like the perfect "jousting" partner for you vincent, at least regarding the gold standard. Here's another:

      http://www.themoneyillusion.com/?p=26186&cpage=1#comment-318891

      Plus he has his own blog:

      http://moneymarketsandmisperceptions.blogspot.com/

      ... one of his papers here on the subject:

      http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2388545

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    2. Thanks! I commented on one of those.

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    3. Posted on James Caton's blog too:

      http://moneymarketsandmisperceptions.blogspot.com/2014/02/were-all-mostly-monetarists-now-not-new.html?showComment=1392687438824#c8685964018874210121

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  13. Vincent, I saw your exchange with Caton. Nice. I added a bit.

    I don't know if you followed my exchange with Nick Rowe, Sumner, Glasner, Sadowski, Cullen, DeLong, Christensen and Koning recently on "How would you summarize good economic policy?" I think you did... and I think you know I liked the Rowe/Sumner/Christensen/DeLong/Sadowski response (paraphrasing):

    "Good monetary policy makes Say's Law appear true in practice if not in theory."

    It occurred to me that what looks like "good monetary policy" to that crowd, looks to you (and to other hyper-inflationists and doom & gloomers in general) like "postponing the inevitable" or "kicking the can down the road." :D

    ... but I say, if we can continue to "postpone the inevitable" forever, then call it what you like, that's what we should be doing! :D

    Ultimately though, I actually do agree with you Vincent, at least in the loooooooooooooooooooooong term: our sun will explode and the universe will eventually experience heat death (and probably long before that we'll get hit with a nice big asteroid). So ultimately I'm a pessimist too. :D

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    1. Tom, if you have a government that is spending way more than it gets in taxes it is sort of bankrupt. If you then have the central bank buy up lots of government debt you can kick the can down the road for awhile. But soon you have a bankrupt central bank (backing not good enough to keep up the value of the currency) and you are headed for a worse problem. Japan, the US, and UK are much more like Argentina and Venezuela than people realize. The central banks get into trouble when they print too much money and loan it to a government that can not pay its debts. Always was so and always will be. We are not talking times like "heat death of the universe", just a few years usually. Mises and many others long ago have understood this.

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    2. When I said, "can not pay its debts" what I really mean is "the only way it can pay off previous loans is to borrow more money from the central bank".

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    3. Vincent I do agree that gov debt in real terms should not grow too fast, but it's easy to come up with a hypothetical example of exponential growth in nominal gov debt that's probably no problem: Say debt grew 1% a year (then nominal debt would double every 70 years!)... but inflation was at 2% a year. Then real debt would actually be exponentially shrinking (halving every 70 years). It's very likely that nominal tax revenues would also be growing exponentially, and probably at a rate higher than the debt growth rate.

      Nominal rates don't matter: just the real rates. I'm not saying that this is our situation right now, but just demonstrates that exponential nominal growth is not necessarily anything to worry about.

      I don't think it's important for the central bank to be buying government debt right now: I don't think the idea is to make a market for Tsy bonds because without the Fed there wouldn't be one. The idea of QE is to lower the demand for MOA: so the Fed could buy anything to do that. Also, they probably are buying too much: more communication from them and less buying is in order.

      I don't think we're close to the case you keep painting that the Fed is propping up the government by buying Tsy debt. I think the market for Tsy debt would be just fine if the Fed started buying something else or stopped buying assets altogether.

      Also regarding nominal vs real rates, the following two rate structures are equivalent:

      Case 1:
      0% = cash rate or deposit rate
      1% = inflation rate
      2% = lending rate

      Case 2:
      -1% deposit rated
      0% inflation rate
      1% lending rate

      Only the second one would require we get rid of cash first. Psychologically, I think people would be more accepting of Case 1.

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    4. Arguing from the point of view of MMs again: any fiscal contraction can be offset (or more than offset) by monetary policy. So if the gov decides to balance their budget, monetary policy should be used to offset the hit this causes to AD = NGDP. If the MMs are right, then we're in no position of the gov not being able to pay it's debts: it can either cut spending or raise taxes or a combination of both and leave management of AD to the Fed. Does that mean looser money? Probably... whatever's required to keep NGDPLT going or mean wage targets on track, or whatever the Fed decides to do.

      Delete
  14. Tom,

    If the crisis didn't happen for 100 years or so, then you might have a point, but if it only takes 10 to 15, then you might have a problem because our children and probably us, depending on our age, are going to have to endure it. I've always said that if ZIRP and QE never resulted (for a century or more anyway) in hyperinflation, then it's actually good monetary policy. The problem is, it's terrible monetary policy which buys a little time before the party ends. Come on, Tom, give it at least ten years to come back to bite them before you say Mises' theory is wrong. Rememer, their ZIRP and QE endgame didn't begin until late 2008. And now, more than five years into the "economic recovery," we still have ZIRP and QE. Even if these policies only buy them ten years, it won't begin to unravel until late 2018. Maybe it buys them 15 years and it unravels in 2023. I'll be 45 years old in 2023. My kids will be young adults in 2023. My parents will by in their early 70's in 2023. I hope Bernanke and Yellen are right, and Mises is wrong. Because if not, then it's going to be a new era in America.

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    1. Neil, thanks for your thoughts. We have recessions on a fairly regular basis: I expect we'll have a recession before 10 or 15 years are up, if not two! I don't expect the next one to be as bad as the last, but I'm not sure. In any case I don't expect it to be a calamity. We'll find out I guess.

      Whatever happens, I'm sure that nobody's theories will be disproved (Mises, Bernanke, or Yellen). Econ is too slippery a beast.

      Nobody really likes QE BTW. Even it's strongest proponents: the MMists. They don't think that QE was necessary on the scale it was conducted if it was just done in a way which gave clarity to expectations: for example having a very strict inflation target, mean wage growth target, or NGDP level target. Instead it was done w/o much communication from the Fed: nobody knows what their intentions with it really are.

      But unlike Vincent, I think that even though the Fed balance sheet is bloated by any measure, that as things stand now, they Fed could put the brakes on inflation very effectively if they chose to. What do you think about my idea of raising the reserve requirement to 167% instantly, and then raising FFR > IOR with OMOs (all w/o the Fed selling a single dollar of long term assets).

      In all likelihood though, the next recession will hit us while ER > $0 and we're at the ZLB on interest rates. And more likely than not, the Fed will just continue to buy assets w/o any real clarity on what they're doing. I agree the situation is not ideal, but I think it's far from a calamity. The only way it's calamity is if the Fed promises to exclude some policy measures up front before anything actually happens. That would be a mistake I think.

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    2. Tom, the Fed has mostly long term debt on its balance sheets. If it tries to sell it this would cause interest rates to go up and the bonds would be worth less. So it would not be able to withdraw as much money as it injected.

      The balance sheet is like 4 times larger than 5 years ago and you don't think it is bloated by any measure? Talk about a skeptic.

      Money in banks is easily pilfered by governments. They might do a bail-in, or a wealth tax, or forced conversion of your deposit to a long term bond, convert your money from one currency to another at any exchange rate they want, etc. Cash on had is safe from a number of such robbery that governments often do. If the US starts talking about a 25% one time (we promise) tax on savings, you can bet people will rush to get cash like you have never seen in the USA.


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    3. Tom, while you may think that 167% reserves is doable, in practice I think more than half the banks would be belly up with such a requirement.

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    4. Vincent, no unwinding of the balance sheet would be necessary if RR was set to 167%. Nor would it be if instead the IOR rate were simply raised.

      Why do you think banks would go belly up? I agree that if after this was done, the FFR was raised above the IOR, then any further expansion of bank balance sheets due to lending, that was not accommodated for with either more LSAT purchases by the Fed, or a lowering of the RR would cause the banks to have to pay (FFR - IOR)% in borrowing costs. But if FFR were left at IOR, or if RR were lowered, or more LSATs were carried out, or some combination of the latter two, this would not put any further burden on the banks.

      Maybe your point is that 167% is an aggregate number and some banks don't have that many reserves and would be forced to borrow from other banks to meet requirements: OK, fair enough, but again, as long as FFR = IOR, this would not actually cause them any expense, but they'd be vulnerable to expenses should FFR be raised above IOR: might make them think twice about any further credit expansion.

      That's part of the beauty of this scheme: after raising RR, then no unwinding would be necessary for the Fed to raise FFR > IOR at any time: it could be done cheaply, easily, and w/o disrupting the bond markets.

      There'd be no need for the gov to pilfer any bank deposits either: this scheme could be accomplished entirely by the Fed.

      Besides, isn't that kind of the point? OK banks, you're OK for now, but you'd better think long and hard about extending any more credit... because we could easily raise FFR > IOR in a moments notice w/o having to do any unwinding of the Fed's BS.

      Probably a much more straighforward strategy would be to simply raise IOR rate: thus raising both the FFR and the demand for MOA (both contractionary measures).

      So what do they pay now on $2.5T of reserves?: 0.25% a year or $6.25B a year... shoot that's nothing! They could probably afford to pay several times that amount (w/o unbalancing their BS too much).

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    5. ... there's never any need for the Fed to unwind it's BS: it can sit on the Tsy debt until maturity: every time a Tsy bond matures, then that destroys a little more base money (assuming the Tsy raises the principal through taxation).

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    6. bloated: Actually I did say it WAS bloated. I don't think anybody thinks otherwise: it doesn't have to be that large: that's a sign of Fed incompetence in communicating what they were doing. But it's not the end of the world.

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    7. Sorry, I read the bloated wrong.

      Ok. Here is a really key point. For the Fed to unwind its BS by just waiting for Tsy debt to mature, someone else would have to fund the government deficit. If the market had to, interest rates would be far far higher. In fact, they would be so high that the government would be clearly bankrupt if it had to pay them. So it is not really an option any longer.

      The MMT idea of looking at the central bank and government as if they were in one black box is a good one. If you do this, what is going on is that the black box is printing and spending money. This is just like Argentina, Venezuela, and anyplace else with high inflation.

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    8. Mark responded to your "black box" comment on themoneyillusion.

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    9. Vincent, this is a bold claim that you should present to Mark directly:

      "Ok. Here is a really key point. For the Fed to unwind its BS by just waiting for Tsy debt to mature, someone else would have to fund the government deficit. If the market had to, interest rates would be far far higher. In fact, they would be so high that the government would be clearly bankrupt if it had to pay them. So it is not really an option any longer."

      I'd love to see his response.

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    10. I'm impatient: I posted it there myself.

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  15. Vincent, I saw that Sadowski had something to say on Argentina today:

    http://www.themoneyillusion.com/?p=26219&cpage=1#comment-319285

    I took the liberty of cutting and pasting your comment about Argentina above into a question to him: I'm assuming that he would disagree w/ you, so I asked for his top two reasons the US is NOT like Argentina (macro/hyperinflation-wise). But maybe he'll scold me and tell me that you are right!

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    1. Tom you are always welcome to take any liberties that increase the chances for a good debate. :-)

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    2. Posted there and wanted a copy here too:

      For each of Weimar Germany, Zimbabwe, Venezuela, Argentina, USA, UK, and Japan please imagine a black box around the government and central bank. Imagine you can't tell what is going on inside the black box between the government and the central bank, all you can do is look at how the black box interacts with the rest of the world. In each case, huge amounts of new money is/was coming out of the black box and being spent.

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    3. Added there and copied here:

      Actually, as long as the banks keep leaving more and more “excess reserves” at the central bank, inside the black box, the net flow of new money is not yet out of control. When excess reserves stop going up or start going down is when the black boxes for Japan, US, UK will really look like the hyperinflation black boxes.

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    4. Looking at excess reserves and black boxes it is sort of like the excess reserves are funding the government deficit, for now.

      Delete
    5. ... do you agree with him? Has every known instance of hyperinflation been preceded by at least a year of double digit inflation (but not hyperinflation)? What's that say about your Japan prediction? Does that mean we really have to see double digit inflation there this year if we see hyperinflation the next?

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    6. ... and to me:
      http://www.themoneyillusion.com/?p=26219&cpage=1#comment-319340

      Did you see that part about the US reaching both it's inflation high (15%) and it's debt as percentage of GDP (33%) low at about the same time? (early 80s)

      This paragraph in particular:

      "The correlations tend to be in the other direction. In the advanced world especially, high levels of government debt are associated with low levels of inflation or deflation (e.g. Japan). With respect to the size of the monetary base, its velocity is closely correlated to interest rates and inflation. Thus a large monetary base is more likely when inflation is low."

      I adjusted my "two big differences" comment to Mark based on his response here. My new two proposals are:

      1. Argentina is not part of the "advanced world" (see Mark's comment)

      2. Argentina has been cut off from the global credit markets.

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    7. http://www.themoneyillusion.com/?p=26219&cpage=1#comment-319386

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  16. The last 4 week treasury bill auction went off at 0.035%. Meanwhile the Fed is paying 0.25% on reserves. The Fed's cost of funding is 0.2% higher than the treasury's. (I don't think you'll find this situation discussed in any econ textbooks! It's really weird/perverse). Seignorage can't be funding the government, since it's negative. The Fed could at least bring up seignorage to break-even if it borrowed from non-banks, which it's experimenting with:

    http://www.newyorkfed.org/markets/rrp_faq.html

    Now it's true that the Fed has been reporting massive profits over the last few years. But this comes from speculative gains (mainly because interest rates haven't increased as expected), not from the difference in yield between base money and safe short term loans. The same gains could have been "earned" by the treasury itself if it had chosen a shorter term of funding.

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    1. Max, interesting, especially the link. I'm not sure how this ties in though.

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    2. Max, I read through that link a bit more and found a bit that I had a question about: I asked Cullen Roche at pragcap, and he answered. It may be of interest to you:

      http://pragcap.com/what-caused-the-great-financial-crisis/comment-page-1#comment-168086

      I'm not sure the following post by JKH is related, but I suspect it is:

      http://monetaryrealism.com/a-new-operating-framework-for-the-federal-reserve-joseph-gagnon-and-brian-sack/

      Both JKH and Sadowski (the latter in a comment) refer to this paper:

      http://www.piie.com/publications/pb/pb14-4.pdf

      I've been too lazy to read much of any of it except Sadowski's comment. Am I correct that these issues are related?

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    3. BTW, here was Sadowski's comment:
      http://www.themoneyillusion.com/?p=26159#comment-318483

      "As a practical matter the fed funds rate is no longer of much importance. Joseph Gagnon and Brian Sacks have argued that the Fed should change its policy interest rate to the soon to be instituted reverse repo rate:"

      ... I think I first encountered this via this comment at pragcap, which makes a stronger claim than what Cullen explained to me about this facility. I tend to trust Cullen more:

      http://pragcap.com/when-will-the-fed-end-its-zero-rate-policy/comment-page-1#comment-167236

      "The Fed doesn’t have to unwind QE before raising rates due to their new overnight full allotment reverse repo facility. With that they will be able to control ST end of the curve while allowing that system to remain in the excess liquidity state." -- Marcin (whoever that is!)

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    4. Yes, same thing. The fact that only banks are allowed to hold reserves has created an arbitrage (presumably by accident, although the Fed hasn't been in any hurry to fix the problem). Actually the simplest fix would be to just let anyone and everyone open a Fed account. But borrowing overnight on the open market would also work.

      Using the established repo mechanism is kind of funny because it involves the borrower posting collateral - as if lending to the Fed were risky! Everyone would be happy to lend to the Fed without any collateral.

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    5. Max, thanks. I'm adding your comment to my "database" on this issue (I keep an unorganized webpage with certain little tidbits I like to remember)

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  17. Most people, and I think Tom is included in this, forget how radical and extreme the ZIRP and QE policies are, and how they were initially regarded even by the mainstream political realm. When these policies were initially rolled out, they were presented as being like a shot of adrenalin, or like the electrical shock to a heart attack victim; an emergency measure to jump start the economy and get things running smoothly again. But now, after more than five years and numerous new all time highs in the stock market, along with all time lows for U.S. treasury bond yields, these so called "emergency measures" are still in place, and are now becoming normal policy to the masses because, after all, we're all still here, and the world didn't end, and everything is still functioning normally, right? Well, yes, it is...for now. But the engine is in the process of overheating, because these radical policies are addictive and become permanent, but also are very destructive in the end. We need to remember common sense, and not let normalcy bias cloud our rational thinking.

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    1. I'm no expert on economic history, but I'm pretty sure QE type operations have been done in the past and for similar reasons. Japan from 2001 to 2006 say (things went badly for them when they stopped).

      Great depression in the US from 1933 to 1937: again, the program was terminated too early and we got a double dip in 1937.

      I think the UK did this too during the same general time frame.

      Neil, I do agree that QE is way bigger than it probably should have been. QE1 looks like the most successful of the three. One theory for that is that it was more like a straight devaluation: the Fed purchased at face value MBS that were not worth it. The subsequent QEs were more equal trades of assets.

      The MMs say that the missing component all along has been communication: what exactly is the Fed doing? The MMs supported QE but say it could have been MUCH smaller if the Fed had communicated: where they trying to boost inflation so it was back to it's target level? Where they trying to boost NGDP? They should be clear, then the market has an idea how permanent the purchases are.

      But again, because they've mostly been swapping equal valued assets, and have been the sole market maker, I don't think what they've done is particularly harmful. Effective: eh, maybe. Harmful: not really.

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    2. BTW, Nick Rowe (an MM from Canada) will point out that the BoC also did QE, but a much smaller program: they were focused entirely on getting inflation back up to target: 2%. And they were able to do this quickly and w/o a massive balance sheet build up.

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    3. ... and as it stands now, I don't think the Fed has even succeeded in boosting inflation back up to target levels: but then again, they have not been terribly clear about their goal with QE either, so perhaps the MMs are on to something.

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    4. Neil, here's a brief summary from Mark A. Sadowski that you might find interesting:

      http://diaryofarepublicanhater.blogspot.com/2014/02/ben-bernanke-proves-sumners-wrong-about.html?showComment=1392522337032#c7994232829032945412

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    5. Neil, I do agree though that QE and ZIRP have been somethings we have not been used to: it's not a typical thing, but it may well be into the future (and I'm not saying that's a good thing... or necessarily a bad thing either). I would personally feel more comfortable if we did get back to a world in which the Fed didn't have a huge balance sheet. My guess is we will, but it'll take some time.

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    6. ... and while I think the Fed's BS is probably bigger than it should be, I still think that more QE is a reasonable response should aggregate demand experience another downward shock in the future (even if the Fed's BS is still large). But I'd HOPE that it would be done more purposefully next time.

      Plus there's other things that can be done that should be tried first or simultaneously: drop IOR to 0% or even make it negative for example... Sweden tried that, and with some success too I understand.

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    7. ...Sumner, Woolsey and others favor setting up an NGDPLT futures market. Michael Sankowski at monetaryrealism.com has criticized the mechanics of Sumner's proposed market, so it may not be very realistic: I'm no judge!. But supposing it could work: I believe that such an approach is very different than QE and probably has a much smaller impact on the Fed's BS.

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    8. "Most people, and I think Tom is included in this, forget how radical and extreme the ZIRP and QE policies are"

      According to Sadowski here:

      http://www.themoneyillusion.com/?p=26219#comment-319386

      "So given the history of the last time the Federal Reserve spent an extended period of time at the zero lower bound, as well as the availability of newer monetary policy tools (e.g. interest on reserves), I seriously doubt that unwinding QE will be necessary, much less desirable."

      By "last time" he's referring to 1932 - 1948. So it's been a while, but it's not like we don't have any experience with it.

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  18. that should read "and have NOT been the sole market maker," above.

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  19. The Fed is not just "swapping equal valued assets." That may have been what the Fed was doing during its "operation twist" where they sold short term treasuries and bought long term treasuries with the proceeds, but that isn't what they're doing with QE. They are creating tens of billions of currency units which did not previously exist and using them to buy securities from primary dealer banks.

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    1. They are paying a market rate for Tsy debt and MBS. They aren't overpaying. Some claim that doing this has driven up the price of Tsy debt. That's a reasonable question to ask... but if that were true, then yields should have dropped. Is that what really happened?:

      http://1.bp.blogspot.com/-BAnvd5XkIkc/UnKFj667RyI/AAAAAAAAAyM/-xbQBsjqcm0/s1600/QE+Rates.png

      Looks like rates at the beginning and end of that chart were close... in spite of it first looking like a general downward trend. But in particular look what happens during and after each specific cycle of QE: rates up during QE, rates down when QE ends. Now those are longer term rates: overnight rates will be approximately equal to IOR as long as excess reserves (ER) exist.

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    2. Neil, when the Fed creates "currency units" it doesn't alter anybody's equity position. Look at it from the bond seller's perspective: they trade a bond for a bank deposit. The bank creates a bank deposit (a liability) for the seller but it gains reserves (assets) in equal measure. The Fed creates the reserves (liabilities) but gains the bond (an asset). No body's equity changed.

      The same happens in the private sector when you take out a loan: the bank gains your signed loan agreement (your IOU to the bank) as an asset, and you gain a bank deposit (their IOU to you). You effectively traded IOUs. Same goes for Fed asset purchases.

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    3. ... if the Fed started paying $100 for each email they received: then they'd be changing equity positions!

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    4. This comment has been removed by the author.

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    5. This comment has been removed by the author.

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    6. I wrote too much (thus the deleted comments!)... but briefly:

      It's no more unusual for the Fed to credit reserve deposits (create Fed liabilities) to buy assets on the open market, than it is for a commercial bank to credit bank deposits to buy (i.e. make) loans or to buy anything else (i.e. pay their electric bill or buy office supplies). Neither case involves the creation of equity, and it's equity that makes us wealthy, not money. I could have a lot of equity and no money and be in much better shape than if I went out and borrowed a lot of money tomorrow (which does nothing for my, or the bank's, equity): and yet borrowing that money would result in more inside money being created by the bank and expanded balance sheets for both of us: balance sheets that could shrink right back down again with very little transfer of wealth (the bank's fee essentially). Same goes for the Fed expanding its balance sheet to buy assets on the open market.

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  20. Vincent, Neil: you guys will love this one:

    http://thefaintofheart.wordpress.com/2014/02/21/the-2008-transcripts-confirm-the-feds-obsession-with-inflation-crashed-the-economy/

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  21. Vincent, I did my best here:

    http://www.themoneyillusion.com/?p=26219&cpage=2#comment-319401

    No surprise on that last bit:

    '“Would Vincent’s warnings about interest rates getting so high that the “government would be clearly bankrupt” have any merit?”

    No.'

    But I was hoping for a little more explanation, but at this point I think I've beaten that horse enough over there... unless you want to dive in. So it's clear where Mark stands, but I'd love to see him directly address the reason he stands there. His 'No' answer was uncharacteristically brief for him, but that might be a sign he's getting tired of this discussion.

    My dream (and maybe yours) is to have somebody like Mark, with oodles of talent and energy and well versed in generally accepted empirical analysis techniques, and all the data he needs at his finger tips, to really address each of your claims head on.

    BTW Vincent, I think one of the things that makes economics difficult is that at it's heart it's a social science and thus it must rely on investigative techniques which are less clear cut than regular science: it's not like we have a box of identical nations we can pull out one at a time and run experiments on. Even if such a box existed, then you'd have a bunch of hand-wringing ethicists whining about it (can you tell that I'm pro-Dr Frankenstein? I say if we can re-animate corpses, let's go for it! Time's a wastin'! :D)

    But along those lines, I think one of the mysteries of a social science like economics or political science, is how a group perceives something and how those perceptions change over time, and what makes them change. In that spirit, I'm willing to grant you something: if enough people were to come to believe that gold is indeed the only true money... enough to reach some kind of mysterious tipping point, then that group perception itself would make it true.

    Likewise, if enough people think the opposite, and inherently believe that paper so-called "fiat" dollars (I use the term, even though Mike Sproul says that "fiat" money is a myth: there are no fiat moneies), do just fine as money, then their perception wins the day, and the public looks askance at the gold standard folks.

    What do you think?

    BTW, that's what's so crazy about social sciences.... this group perception thing has no place in real science: it doesn't matter how many people believe the Earth is flat: their perceptions don't make a wit of difference as to the truth or falsity of the hypothesis.

    ReplyDelete
    Replies
    1. "Financial markets have a very safe way of predicting the future. They cause it." - George Soros

      I like this quote, even though it's too simple, because there are also stabilizing influences. In the case of U.S. debt, the government has the ability to raise taxes and cut spending. It's not helpless in the event of a fiscal crisis. (If it were helpless, then the debt could be rightly called a bubble, and self-fulfilling expectations would rule).

      Delete
    2. Max, I agree: the gov could always raise taxes and cut spending. If the MMs are to be believed this kind of fiscal contraction can be offset via monetary policy: I don't know if I believe it completely, but I'd bet that's at least partly true.

      If you look at my links to Sadowski's reactions to Vincent's statements on themoneyillusion.com, you'll see that by a lot of measures the US is actually worse off than Argentina (Sadowski digs up the stats), but then he points out that in the "advanced world" our current situation is correlated with low inflation! He then shows that our high inflation period (post-WWII) was actually at a time when our stats looked much "better" in terms of national debt, etc. Thus I repostulated two big diffs between the US and Argentina is 1) Argentina is not part of the "advanced world" and 2) their access to credit markets has been cut off. He didn't get back to me on that. I'd like a good definition of "the advanced world."

      Delete
    3. Argentina has recently (2001) defaulted and for good reasons they aren't considered particularly competent and trustworthy. More faith in the authorities is justified in the case of politically stable, relatively well-governed countries.

      Delete
  22. Neil, I know next to nothing about Hayek, and even less about Mises, but this caught my eye:
    http://www.themoneyillusion.com/?p=26219&cpage=2#comment-319421
    So did the "Mises-Hayek business cycle theory" really lead Hayek to adopt MM type views? "...not a constant money supply, but a neutral money supply" sure sounds MMish to me. It sounds like keeping AD on trend. :D

    ReplyDelete
  23. Vincent, Noah Smith says Japanese inflation is only 0.7% (well short of it's 2% target) if you measure it the way we do in the US:

    http://noahpinionblog.blogspot.com/2014/02/japanese-inflation-isnt-as-high-as-you.html

    ReplyDelete
  24. JP Koning, has another fascinating article about fiat money:

    http://jpkoning.blogspot.com/2014/02/when-money-ceases-to-be-iou.html

    ReplyDelete
    Replies
    1. Cool! I have added another explanation for hyperinflation to my list. Fiat money is a bubble, hyperinflation is when the bubble pops. Thanks!

      Delete
    2. John S. there links to this Glasner article on gold, which I'd read but forgotten about:
      http://uneasymoney.com/2013/04/19/the-golden-constant-my-eye/#comment-17154

      Delete
    3. ... in the comments on JP's, John S. says Glasner has repeatedly called gold an "irrational bubble."

      Delete
  25. you might find interesting:
    http://realfreeradical.com/2014/02/27/is-fiat-money-an-iou/

    ReplyDelete
    Replies
    1. Thanks. I commented there.


      I have been busy with work. Going into real estate. Check out http://realestate.ai/

      Delete
    2. Vincent, Mike responds to you:
      http://realfreeradical.com/2014/02/27/is-fiat-money-an-iou/

      Delete
  26. Tom, on what Mark was saying about getting lots of time with inflation before hyperinflation. If you define hyperinflation as 50% per month, then you will get some high inflation first. If you go with 2% per month you may not get much warning at all. So I think how much warning time you usually see depends on how you define hyperinflation.

    ReplyDelete
    Replies
    1. 2% a monthy (~24% a year) sounds like very high inflation, but really hyperinflation? What are the chances it goes from that to what is traditionally called hyperinflation?

      Also what about the correlations Mark demonstrated in the "advanced world" specifically the US?

      Time of worst inflation in the US post-WWII: early 80s: also the time that the debt to GDP ratio was the lowest.

      The opposite has also been true in both the US and Japan: large debts, large monetary base correlated with low inflation.

      Delete
    2. read the first section of my hyperinflation faq where I talk about the definition:

      http://howfiatdies.blogspot.com/2012/10/faq-for-hyperinflation-skeptics.html

      Delete
    3. Another Sadowski quote today:

      "To be clear, I don't think there is any contradiction at all between the statement that the growth in money supply and NGDP is high in countries experiencing hyperinflation and in saying that the monetary base as a percent of GDP is relatively small in countries experiencing hyperinflation."

      So, the monetary base as a percent of GDP is relatively small in countries experiencing hyperinflation... what do you think Vincent? Do you agree?

      http://diaryofarepublicanhater.blogspot.com/2014/03/market-monetarism-and-supply-side.html?showComment=1393706612576#c4307246198865339134

      Delete
    4. Yes, Mark is right. The velocity of money goes up really high so that the real value of the money supply as a percentage of GNP is relatively small.

      Delete
  27. Vincent, did you see this Mike Sproul comment:
    http://jpkoning.blogspot.com/2014/02/the-cost-of-manufacturing-liquidity.html?showComment=1392652641149#c2747714437021819015
    The implication is that the danger to the value of the dollar (when the number of dollars has been multiplied by the CB buying bonds) is not so much in the fear of what those future dollars are worth, but in terms of the loss of value in the "anchor" (he hypothesized that some of the CB's gold was stolen).

    ReplyDelete
    Replies
    1. There is often more than one good way to think about a problem. My hyperinflation list is over 30 now, many of them good.

      Remember, JP agreed with me that there is a danger of an adverse feedback loop when using 30 year bonds to back your currency. In this case there is no real anchor. If the currency goes down, the bonds go down, if the bonds go down, the currency goes down. There is nothing to stop it, as long as the government has a huge deficit. If the government had a surplus, then taxes could be removing currency.

      Delete
  28. Sumner is asking a question:
    http://www.themoneyillusion.com/?p=26274&cpage=1#comment-321548

    ReplyDelete
    Replies
    1. Thanks! I commented

      http://www.themoneyillusion.com/?p=26274&cpage=2#comment-321624

      Also liked the comment by Mark on the troubles of high debt levels.

      Delete
    2. Vincent, I didn't see your comment at first, so I thought I'd answer on your behalf. I think you missed an opportunity to give Scott a very specific answer (you would have been the 1st one), so I did it for you.

      If you don't agree, please correct or let me know here, and I'll go correct my mistake. Here's what I wrote:

      http://www.themoneyillusion.com/?p=26274&cpage=2#comment-321696

      Delete
  29. For more than 2,000 years an ounce of gold has been about the value of a nice suit, shoes, and belt.--Vincent Cate.

    I believe in regulated money growth, or shooting for NGDP (Market Monetarism).

    I might even like the idea of banks matching assets to liabilities (or setting aside larger reserves in some sort of prorated way).

    But please, gold and the suit of clothes is a goal wide enough that I could kick it in during the next World Cup.Both teams defending.

    In Los Angeles, I can buy a "nice suit of clothes" for anywhere between $200 (garment district, smarty-style shopping) or $3,000 and up (Beverly HIlls retail). What is nice? For $700 you can get a suit of clothes to die for.

    A nice suit of clothes cost what in 1980 and what in 2000?



    Some people try to line up gold and oil, with very awkward results, as in they do not match up.

    Actually, gold does not even line up with silver. The old ratio was 15 or 16 to one, but that has been shot out of the water. Well, at leads gold hasn't gone the way of aluminum lately---down for decades. But it might.

    ReplyDelete
    Replies
    1. Paper money changes in value by factors of 10, 1000, 1000000, etc in 25, 50, or 100 years. Gold might have changed in value by some amount, but less than a factor of 10 in 2000 years. Gold is far more stable than paper money.

      Delete
    2. Why is long term average stability better than a rock steady modest rate of devaluation? Recall that even a small rate of devaluation (e.g. 1% a year) is still an exponential, so it still blows up, thus providing an opportunity to scare someone who's bad at math.

      Long term average stability says nothing about volatility on time frames important to the economy or individual humans.

      Delete
    3. Even small exponentials blow up. But most paper money does not stay with small exponentials. Perhaps I have not mentioned it, but I think even the Yen, Dollar, and Pound will not be staying with small exponentials much longer.

      Delete
    4. "Even small exponentials blow up" ... I agree completely! So just use logarithms. Problem solved. But seriously... that's kind of what I think. There's a degree of psychology to all this. What is considered to be an "acceptable" inflation rate? Well if in the future Siri is managing our accounts every micro-second, perhaps we can tell her to please just quote prices, income, etc in terms of year 2000 dollars so we don't have to do the math. All that matters is real income and prices ultimately, right? I could see a future where even 100% inflation is fine as long as real incomes are doing well. Not that we want to shoot for that, but if that's what the market expects, and that's what's delivered, then I don't see a problem. I also think that Miles Kimall and Bill Woolsey's proposals for 0% inflation are fine... however they both imply deposit rates of < 0%... which is also fine... except that it's just another psychological barrier. (In Miles' proposal there's either no cash or cash is left to float against deposits so it would provide a negative nominal return, if deposits are the "anchor"). It makes perfect sense to me that if 0% inflation is targeted then cash and deposits will provide a nominal return < 0%.

      Both Sumner and Rowe think that given our current situation with cash fixed at a nominal 0% return, that if the CB were to target 0% inflation it would mean the CB would have to own a LOT of assets (way more than they do now: bordering on "socialism"). Honestly, I don't know why, but it'd be interesting to find out.

      Coming back to present day reality, don't think people will accept negative deposit interest rates or cash floating against deposits, nor do I think they'll accept 100% inflation rates. I think they grudgingly accept low (single digit) inflation rates. It's all about the psychology. And I think everyone likes to be able to know ahead of time what the rate will be. It makes planning a lot easier. And I don't mean the long term rate (like what it will be if we consider the next 1000000 years) I means what it will be this week, this month, this year, and for the next decade.

      As to whether the Yen, Dollar and Pound will be staying with small exponentials much longer, I guess we'll find out!

      Delete
  30. Vincent, Beckworth looks at the gold standard:
    http://macromarketmusings.blogspot.com/2014/03/the-gold-standard-was-accident-of.html#comment-form

    ReplyDelete
  31. Vincent Cate:

    Gold is more stable than paper currency...probably true given the Zimbabwes of the world.

    But how about since 1979? Has gold been more stable than the US dollar?

    Eyeballing the charts, gold has soared, then went into long--term decline and cratered, then soared again, an maybe now is in another long-term crater.

    The dollar sagged in a steady sort of way.

    This suggest that gold is not more stable than the US dollar, in the modern world.

    ReplyDelete
  32. Vincent, good luck on getting some good answers from Sumner! Really... I hope he answers your questions, I'm very curious to see the replies. He's not inclined to go read a link somebody provides him though, unless it's to a big name: Like Nick Rowe or Tyler Cowen or something. I tried to get him to look at a question I had for him on my blog, and he refused. :D

    ReplyDelete
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