Saturday, April 3, 2010 106 Comments

The credit-default swap and the bullion banks; a question and a statement

I apologize for the unusual lack of content on UR. I have been visiting with family, have been working quite a bit on Nock/Watt, and sending too much email to Larry Auster.

(Ponder the fascinating, even (dare we hope?) historic, interaction between Auster and David Mills. I knew Mills had some kind of Hollywood job, but had no idea he was such a big shot. Undercover Black Man, RIP - a real-life Giant Negro. Alas, the real pass and the fake live on.)

Also, I note that the legitimacy of maturity transformation has somehow become a legitimate topic of public conversation. As Kling says:
Evidently some radiation from Mencius Moldbug has leaked into Harvard Yard.
Or not. Let's not forget that a discovery is not an invention. The truth, being true, is accessible to all - though not all will get it all. And so far as I'm aware, all priority is due to Mises (1912):
The credit that the bank grants must correspond quantitatively and qualitatively to the credit that it takes up. More exactly expressed, "The date on which the bank's obligations fall due must not precede the date on which its corresponding claims can be realized."
Ie: maturity transformation considered harmful. And no one, except Professor Bagus, even gets this citation right. Such is scholarship, in the early 21st century.

Still, the truth is the truth and it is always nice to see people stumbling over the thing, even if they kick it in the wrong direction. And even though it contradicts my predictions and corrodes my pessimism. My pessimism is restored, however, by seeing how few of these distinguished professors understand the problem completely and correctly. More on this later.

We proceed to the matter of the title. I wanted to just briefly make one statement and ask one question. The statement is true, so anyone who cares to believe it may believe it or not. The question is one whose answer I do not know. The information is not public. However, it is quite important, so if anyone has it, they should feel free to disclose it to me. I have a guess at the answer, but I could easily be wrong.

The statement is: the credit-default swap is not a free-market financial institution.

The question is: are bullion banks net short in the metals market?

Let me deal with the question first. First, I know that bullion banks (ie, financial intermediaries which maintain a balance sheet in gold and/or silver - which, these days, are generally subsidiaries of much larger, more important banks specializing in funny-looking little pieces of paper) are transforming maturity in gold and/or silver. This is why they're called "banks." My question is not whether they are transforming maturity, but whether they are (as some claim) net short.

The conventional explanation of the bullion bank is that the bullion bank is not net short. Rather, it has a neutral position, with gold assets balanced by gold liabilities, so that the bank does not suffer automatic and trivial gains and losses, as accounted in either dollars or gold, when the gold-dollar ratio goes up and down. Similarly, a regular bank which calculates its accounts in dollars does not balance these with loans in euros, because then its solvency would be exposed to a highly unstable variable, the dollar-euro exchange rate.

The bank is a maturity transformer, however. It sells gold short and buys it long. Again, this is what a bank does. So, for instance, it balances a liability, such as a promise to deliver Comex gold in 3 months, with an asset, such as a promise by a gold miner to grind up that mountain over there and suck it through a pond of mercury, 3 years from now. The only difference between this and regular banking is that gold is a natural currency, not a fiat currency.

I respect this explanation considerably. One, it is very plausible. Two, I once asked a fellow blogger whom (a) I greatly respect and (b) has experience (albeit from the '80s) in bullion banking, and he confirmed that, from his perspective, it would be shocking if a bullion bank were to carry such a dangerous exposed position.

Against this we have the various disclosures made from GATA etc - including, most recently, the strange story of Andrew Maguire. The best I can say is that this is a noisy, untrustworthy source. For one thing, it does not appear to me that they have any individual or collective clarity on the distinction between maturity transformation (which is bad) and net shorting (which would be really bad). They strike me as honest, but not entirely and completely clueful.

For instance: when Jeff Christian says that there are "multiples of hundred times" more "paper gold" than actual gold in London, by "financial gold" does he mean "unbacked promises to deliver actual gold" (ie, "naked shorts") or "forward contracts to deliver actual gold?" Of course, mountains are hard to grind and so on, and not all contracts will be delivered. However, there is a very important qualitative distinction between these answers.

For those who feel the bullion banks are neutral, I ask: if Comex gold shorts are balanced by long forward hedges, why does the Comex open interest of commercial sellers, that is, bullion banks, fluctuate dramatically on a short-term basis? Forward mining sales, etc, wouldn't do that.

Where are all these legitimate hedges? How much gold has actually been sold forward? For the past few years, gold miners have been shrinking their hedgebooks. Has the amount of "paper gold" in London decreased accordingly? According to GFMS at the link above, there are only 236 tons of legitimate commercial promises to ship forward gold, half of which are financial in nature. There are 25 tons of actual gold due and presold from the gold mines in 2010; 30 in 2011. Annual gold production: 2,000 tons.

Why does bullion banking even still exist? And what was Jeff Christian thinking when he said, under oath,
August of 2008 when there was an explosion in the short positions in gold and silver held by the bullion banks on the futures market and he seemed to imply that that was somehow driving the price down. If you understand how those bullion banks run their books, the reason they had an explosion in their short positions was because they were selling bullion hand over fist in the forward market, in the physical market, and in the OTC options market. Everyone was buying gold everywhere in the world, so the bullion banks who stand as market makers were selling or making commitments to sell them material and so they had to hedge themselves and they were using the futures market to do that.
Translation: the short position of the bullion banks exploded. To balance this short position, they purchased a long position... from whom? "Themselves" is not a valid answer.

Everyone was buying gold. Therefore, the bullion banks had to sell a lot of paper gold. They sold so much paper gold that, even though everyone was buying gold, the gold price went down. Everyone was buying gold, but the bullion banks wanted to sell even more paper gold than everyone wanted to buy. Hence, in the unified actual-gold-and-paper-gold market, demand increased, but supply increased even more than demand increased. Hence the price went down.

Christian's theory, expressed later as a correction, that other random investors in August 2008 were liquidating long positions, does not strike me as reasonable. Who, exactly, holds all these long forward positions in gold? There is a name for an entity which holds long forward positions in gold: a bullion bank. Ordinary large investors, when they hold gold, seem to generally hold futures, sometimes ETF shares. (In the first case a dreadful mistake, in the second demanding strong due diligence.) If futures are liquidated, open interest goes down, not up. If ETF shares are turned into metal and sold to India, it does not change. But in fact, it went up.

This seems like convincing evidence that the bullion banks are net short. However, it just does not make sense to me that the bullion banks are net short. For one thing, I trust my source. For another, gold prices have generally been rising over the last decade. If the bullion banks were net short, they would have been losing money continually throughout this period. This perhaps could be offset by some pattern of manipulation, but it seems like a very ugly, un-bankerly way to make a dime.

When the impossible is eliminated, all that remains is the improbable. Therefore, my guess is that "paper gold" is effectively, although perhaps tacitly, backed by sovereign gold reserves, many of which were "leased" (ie, balanced with short sales - or, if you prefer, traded for paper gold, or "gold deposits," at bullion banks) in the '80s and '90s.

It is not clear whether the US gold reserve has ever been so encumbered. It would not need to have left Fort Knox to do so - given modern financial engineering. After all, by holding 8000 tons of gold, USG is long 8000 tons of gold. It can certainly afford to sell a few paper promises of gold, future or present. It is not exactly authorized to do so, but words have been bent before.

This would require a remarkable amount of collusion between bullion banks and governments - in the case of 2008, for instance, it would mean that it was actually USG (and friends) that was minting the paper gold, the banks just being low-level pushers of this paper. Without being net short, the bullion banks cannot manipulate the market; they can only profit (perhaps with a bit of front-running) from higher powers which manipulate the market. Short of aliens or Elvis, this can only be the OECD governments. It can only happen with at least the consent of Washington.

If this is a fact, it is not a fact calculated to attract serious and thoughtful investors to "paper gold." Basically, it means that these governments are surreptitiously using (and, inevitably, consuming) their gold reserves, to artificially increase the price in gold of their paper currencies. It is very easy for people who want to hold gold to exit from this scheme, by holding actual gold and not paper gold.

On a historical scale, this is not shocking at all. We know that the same thing was going on as recently as the '60s, with the London Gold Pool. But on a historical scale nothing we mention here at UR is shocking. On the scale of current events, this conclusion is quite shocking - because no such scheme can withstand any serious exposure. Again, those who want to get out, can get out. (Even the fact, acknowledged by all, that gold futures are maturity-transformed, is more than enough reason not to hold gold futures. RIP, bullion banking.)

Moreover, if my supposition is indeed correct, there are two questions. One: are the OECD governments, themselves, net short? Ie: have they issued less paper gold than the actual gold they hold, the same amount of paper gold, or more paper gold? The last would be madness for a mere private enterprise, but a sovereign can get away with a lot. Heck, it's pretty much the way we got the fiat currency we have. Also note that these governments have quite a bit of gold - but very little silver. And the same patterns are seen, even more distinctly, in the silver market.

The most significant fact about this mess, which I think almost everyone has ignored, is that USG and its little friends just do not have the political and economic strength to either (a) peg the price of metal to dollars, etc, (b) make dollars, etc, freely competitive with metal, or (c) prevent private citizens from hoarding metal (eg, with a 1933 style gold confiscation). Is there a (d)? There must be, but here my magic 8-ball becomes quite murky. It is also very unclear how long this game, if it is the game, can continue.

So on to the second point: credit-default swaps. This is quite clear. A credit-default swap is not a free-market financial instrument.

Why? Because there is only one reason why a party holds a CDS. They have government permission to overvalue these securities on their balance sheets. CDS are an artifact of incorrect government-mandated accounting (specifically, via the NRSROs).

What is the market value of a CDS? There are two answers, A and B, the wrong answer and the right answer. The wrong answer is: the market value of a CDS is the chance that the credit default will happen, multiplied by the face value of the CDS. X times Y.

The right answer is: the market value of a CDS is the chance that the credit default will happen, multiplied by the chance that the CDS issuer will not default, multiplied by the face value of the CDS. X times Q times Y. So, if you buy a CDS on an IBM bond from AIG, its market value is the face value, times the probability that IBM will go bust, times the probability that, if IBM goes bust, AIG will not go bust.

Now, the people who invented these things are not actually stupid. They didn't forget about Q. What they said was: Q is the probability that AIG will go bust. They then said: AIG has an AAA credit rating, which means it will never go bust, with 99.999% probability or whatever. Setting Q to basically equal 1, they then arrived at the desired calculation of value, ie, X times Y.

But this is just bad probability, which makes it bad accounting. The probability that AIG will go bust if IBM goes bust is a conditional probability. X and Q are not independent variables. For one, AIG, having written a lot of these IBM CDS, will lose a lot of money if IBM goes bust. And any event that affects IBM may affect other companies on which AIG has also written swaps.

The CDS buyers also required (or should have required) AIG to collateralize these positions. But collateral, too, is not a magic amulet against counterparty risk. If you've insured $3 billion worth of diamonds, and you only have $100 million to cover them, when the probability that the diamonds are stolen flips from very low to certain, someone will get burned. It's just math. Until capital equals exposure, someone has to end up holding the bag.

Collateralizing an undercapitalized insurance market does not protect the market from insolvency. It just means the market melts down in a flash, as all positions are liquidated - the price of CDS will rise faster than the sellers can buy back their CDS. Someone won't be able to; and whoever holds his CDS will experience the ugly stick of Q. If collateral is centralized through a clearinghouse, that clearinghouse must be able to cover all the diamonds it insures, or the clearinghouse has significant default risk.

As we saw in the case of AIG, of course, the problem was solved. Who wound up holding the bag? You, of course, dear taxpayer. And this is why I say that CDS are not a free-market instrument. The Q is all on you.

The basic problem with CDS as a free-market instrument is that, while there is quite a bit of demand for the product of exposure X * Y, there is little or no demand for X * Q * Y. For instance, if you buy an IBM bond and an AIG CDS against it, you have replaced your exposure to an IBM default with exposure to an AIG default.

In reality, no party (except USG) is really so much more financially secure than IBM, that it's worth writing insurance on IBM. The financial product that the market demands is not CDS, but CDS without counterparty risk. This is a useful product indeed, but not a free-market product. No free market can produce any such thing - it takes a fiat-currency issuer. To guarantee IBM's loans risk-free, you would need to cover every dollar of IBM loan with an insurance dollar, which would be ridiculous, unprofitable, stupid, and completely defeat the purpose.

Thus, people buy CDS because (and only because) incorrect accounting principles allow them to incorrectly disregard Q, the probability of the CDS issuer defaulting, thus assigning these securities excessive value on their balance sheets. When they become insolvent as a result of this miscalculation, USG's infinitely-flexible rubber-dollar absorbs the slack, and the Fed becomes the new team sponsor of Manchester United.

Well, thank god for funny money! If not for M. Danton's beautifully-engraved new assignats, there would be no commerce and no work for anyone, and we'd all be sitting around on our butts, blogging and watching Manchester United. Or so Paul Krugman would have you think.

106 Comments:

Blogger Chris said...

So, CDS is not free market because USG ensured irrational counterparty risk pre facto, depended the banking system upon this ensurance, and indeed insured it post facto?

Furthermore, no CDS where the risk of the insurer defaulting exceeds the risk of the insured instrument being in default, would be purchased by rational market participants?

April 3, 2010 at 10:47 AM  
Anonymous Anonymous said...

I apologize for the unusual lack of content on UR. I have been visiting with family, have been working quite a bit on Nock/Watt, and sending too much email to Larry Auster.

Have you been emailing with Auster about how evil and gnostic breast implants are?

April 4, 2010 at 12:52 AM  
Anonymous Steve Johnson said...

This post states better and clearly my thoughts on the Megan McArdle post about CDS where she asks if they should be banned.

Why should we ban them?, she asks.

Well, because party G bets party A more money than A has that some event won't happen. If that event indeed does not happen, party G profits because he profits if the event does not occur. If the event does happen, party A runs out of money but the fed steps in and makes party G whole.

Meanwhile, party A pays out bonuses based on the value of selling event insurance. Party G pays bonuses on no-event bonds. If the event happens, no sweat, party A dissolves and the people who ran the scam move on to somewhere else (keeping their cut of the bets).

Anyone here have a AAA rating and is willing to bet 50 billion dollars that the sun will rise in the west tomorrow? I can make us both rich.

April 4, 2010 at 1:06 AM  
Blogger Bron said...

"Has the amount of "paper gold" in London decreased accordingly?"

Because London is an OTC market, we can never know the amount of paper gold actually issued. It is interesting however to note the decline in LBMA clearing from around 30moz per month in the mid 90s to 20moz today (http://www.lbma.org.uk/stats/clearing) in the face of increasing interest in gold. It is net clearing so could reflect consolidation in the bullion banking game over that time as well as decreasing hedging by miners.

"if Comex gold shorts are balanced by long forward hedges, why does the Comex open interest of commercial sellers, that is, bullion banks, fluctuate dramatically on a short-term basis?"

My view is you have this backward. Bullion bank short futures are created in response to long future demand. As you say large investors go long futures, this would result in an increase in future prices in the absence of matching supply (ie speculators willing to take the other side of the bet or miners looking to sell).

This would create an increasing gap between spot (physical) price and the future price, and when large enough a gap, resulting in an arbitrage that the bullion bank takes advantage of. They profit by borrowing cash, buying physical gold at spot and selling future gold.

Open interest fluctuates short term because investor bull/bear sentiment fluctuates and bullion banks, in their bread and butter market making role supply long or short futures to meet this (net) changing demand.

I note that open interest rarely got above 200,000 from 1982 to 2002 but since 2002 shows a clear upward, but fluctuating, trend from 200,000 to 470,000. Also COMEX warehouse stocks (eligible and registered) goes from 1moz in 2001 in an almost straight line to 10moz today.

I tend to agree with your analysis that "gold prices have generally been rising over the last decade. If the bullion banks were net short, they would have been losing money continually throughout this period."

Do bullion banks run proprietary positions that may be short? Yes. Could they officially be (or have rouge traders who are) using their market power to manipulate the price to profit in the short term? Possible. But to be continually short over a decade in the face of a rising gold price? I don't think so.

To do so speaks of a philosophical hatred towards gold that I can't see a banker having. There is more (safer) money to be made making the spread between the lovers and haters that taking a side yourself.

April 4, 2010 at 6:22 AM  
Anonymous Anonymous said...

Far right member of a Pro-Afrikaaners party has been assassinated in South Africa, in the usual manner befitting evil white colonialist overlords of course i.e. hacked to death by a machete.

If you haven't read progressive sites in awhile, then now is a good time to watch them transmogrify from supposed stalwarts of peace and multiculturalism, to their reptilian V-esque orgy of bloodlust.

Metafilter is particularly good (where one post has already been deleted by a member accidently splooging himself): http://www.metafilter.com/90702/Cause-meet-effect

http://www.metafilter.com/90701/Galatians-6-79-FTW

April 4, 2010 at 6:25 AM  
Blogger Richard said...

This post hints at the fundamental issue at AIG: the correlation between the risk that the contingent liabilities on AIG's credit default swaps would be triggered and the risk that the firm would all insolvent. After AIG stopped selling credit default swaps on subprime MBS in 2005, AIG in fact greatly increased this correlation by purchasing more than $60 billion in subprime MBS for its own investment portfolio. This "correlation-seeking" activity was rational from a shareholder perspective, even though it deepened AIG's losses when the housing market collapsed.

I describe this key aspect of the economics of contingent liabilities in this article, just published in the Harvard Law Review:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1394995

April 4, 2010 at 9:17 AM  
Anonymous PA said...

Breast implants may or may not be gnostic, but they certainly are evil. As is anything that disfigures a woman, especially an already-attractive one wiht normal titties.

There isn't a huge degree of difference between those who think plastic boobie inserts improve a woman's looks and the primitive African tribes who think a chickenbone through the nose or a 9" saucer in the lower lip does the same.

April 4, 2010 at 10:22 AM  
Blogger gwern said...

PA: The difference I'd say is that breast implants can give women better looks - there are many women who are undersized - while I've never seen a woman who would be improved by a chicken-bone or saucer.

April 5, 2010 at 12:51 PM  
Anonymous Anonymous said...

Perth Mint

Goldmoney

Are these "bullion banks"?

They appear to be (safe) depositories.

April 5, 2010 at 3:44 PM  
Anonymous zanon said...

DIfference between bullion bank and fiat bank is larger than you think.

Bullion bank does borrow short in order to sell long.

Normal bank does not do this. It lends long, and by doing so, creates short. It does not lend out deposits, it extends loans which create deposits.

Bank with 0 loans can create deposits as allows by regulatory capital.

April 5, 2010 at 9:44 PM  
Blogger Mitchell said...

Does anyone think Mencius could be regarded as an anti-Voltaire? A pamphleteer writing in favor of personal rule, late in the age of democracy, rather than a pamphleteer writing in favor of democracy, late in the age of personal rule.

April 6, 2010 at 1:19 AM  
Anonymous josh said...

"It does not lend out deposits, it extends loans which create deposits."

This is not intuitive to me. Link or explanation would be appreciated.

April 6, 2010 at 4:52 AM  
Blogger Ursus said...

So it seems that governments are using bullion banks as middlemen in an attempt to inflate paper gold. Why would they do that? Probably because, as you said, they want to keep the exchange rate against gold for their currencies artificially high.

How do you tell the difference between being in an elevator car accelerating at 1g outside any gravitational field, or an elevator car standing still in an 1g gravitational field?

In the absence of an absolute frame of reference in physics there is no difference.

In economics there is a mostly absolute frame of reference that changes only slowly: the price of gold.

So if governments want to paper over the windows of the elevator and lie that "The economy is not in freefall!" they must corrupt the absolute frame of reference.

What would gold cost in the absence of manipulation?

Are we already in a period of hyperinflation masked by every currency hyper-inflating at similar rates?

I predict that the next J M Keynes is already working on his book and looking forward to his Nobel. The original said "Government borrowing is not only not bad, it is good!"

The Second Coming of J M Keynes will say "Hyperinflation is not only not bad, it is good!"

April 6, 2010 at 7:12 AM  
Anonymous zanon said...

josh:

you have many options:
http://www.winterspeak.com/2010/02/post-keynesianism-in-nutshell.html#links (read part 2)

Or "required readings" at warren mosler (find via the Google)

In short: when you loan $20 to friend, you do not have access to that $20 until friend repays you.

But when banking system lends $20 to your friend, it gets that $20 back immediately, either when the friend puts the money in his bank account, or when the friend buys something and the person he bought something from then deposits the $20. Central bank links all banks via reserve accounts, so they make loans that then create the deposit. The only think limiting quantity of loan bank can issue is number of worthy borrowers on demand side, and capital/capital requirement on supply side.

April 6, 2010 at 8:52 AM  
Anonymous zanon said...

another option if you can wade through all the tiresome prattling:

http://bilbo.economicoutlook.net/blog/?p=9075

April 6, 2010 at 9:13 AM  
Anonymous Michael S. said...

Ursus, your comment about Keynes should remind us that governments were already engaging in "Keynesian" policy (deficit spending, abandoning the gold standard) before Keynes wrote his "General Theory."

Keynes provided theoretical justification for the economic activities of politicians in just the same way as he and his fellow Bloomsberries rationalized their own sexual misbehavior. The parallel is striking.

April 6, 2010 at 9:19 AM  
Anonymous josh said...

zanon,

I think I just had a holy sh!t moment. I thank you. I'm going to have to let this marinate.

Is this operationally much different from MMs model of "protected maturity transformation" wherein lending and deposits are fundamentally separate activities and the government has essentially given banks the license to print money and loan it out? Or is it just more detailed?

April 6, 2010 at 10:08 AM  
Anonymous zanon said...

josh:

Good for you having oh shit moment. Trying to explain this to austrians who are on this site is sisyphus task.

it is different from MMs theory, as MM does not understand balance sheets, and to talk about finance you need to talk in balance sheet.

if you make loan, you must create deposit. the question is -- what is balance sheet implication?

as individual, when we make loan we change compsition of balance sheet as one asset (cash) is swapped for another (IOU). But bank expands both sides as IOU (asset -- receivable) is balanced with deposit (liability).

Primary purpose of reserve account is payment settlement, so you have these no matter what rules you put around credit.

For MM world to make sense, he needs to ban private sector credit. Maturity mismatch is, I think, red herring.

April 6, 2010 at 11:22 AM  
Anonymous Sam said...

zanon,

What's your opinion of Austrian economics in general?

Obviously you think that it's wrong on banking and monetary/financial economics. I suspect you think that it's wrong on macroeconomics in general as well, though I'm not sure if this is your position as most of your comments here focus on banking.

But what about microeconomics and the other parts of Austrian theory? Are they flawed as well? If so, which economics in your estimation is most reasonable and worth studying?

I ask all this because I'm trying to study and learn economics on my own in my spare time, and I want to make the best and most efficient use of my time and avoid getting led down ideological dead ends and bogged down in politics.

April 6, 2010 at 12:54 PM  
Anonymous Anonymous said...

I used to read David "Undercover Black Man" Mills' blog. It was very good (and would've been even better without all the posts about dull negro music). He used to comment not only at Auster's place but also at AmRen and some other WN/HBD sites. He was an HBDer, believing in black cognitive inferiority, which is a tragic position to take for a black guy (he looked like a quadroon though).

April 6, 2010 at 1:13 PM  
Anonymous zanon said...

Sam:

Austrian Macro does not understand how current US financial system work and will in fact lead you astray.

It is not bad for older financial system, so it is value as something to study depends on what you want to understand.

Academic macro is also quite useless, as frankly it is austrianism with the coherence removed. Monetarism is total joke.

If you want to understand, you need a fringe discipline called Modern Monetary Theory (MMT), or Chartalism, or Soft Currency Economics. Warren Mosler or Winterspeak are good, but their sites suck. Billy Blog is crazy communitist and wordy, but understands this. Steven Keen is dangerous character half right half wrong -- approach with caution. And oh yes, anything a commentator called JKH says is correct.

For microeconomics I think standard textbook micro/libertarianism is fine. Best critiques of standard micro come from Udolpho actually IMO

April 6, 2010 at 2:37 PM  
Anonymous Sam said...

zanon,

Thanks for the info. I've heard of some of those names such as Winterspeak, Mosler, etc.

I've never heard of "JKH" however. Where does he comment?

Also, has Mencius ever critiqued Post-Keynesianism or responded to criticisms of Austrian econ by Post-Keynesians, here or elsewhere?

April 6, 2010 at 4:06 PM  
Anonymous Anonymous said...

"Academic macro is also quite useless, as frankly it is austrianism with the coherence removed. Monetarism is total joke."

What does "austrianism with the coherence removed" mean?

Why is monetarism a total joke? Isn't it not that different from Austrianism? Isn't it much closer to Austrianism than the other side of academic macro i.e. Keynesianism?

April 6, 2010 at 6:47 PM  
Blogger chairmanK said...

Mencius, I am disappointed by your linking, and implied interest in, the "various disclosures" from GATA. You admit that the supposed "whistleblower" Andrew Maguire is a "noisy, untrustworthy source" and "not clueful". On casual inspection of the GATA blog, you and all the rest of the bicoastal progressive elite who have a proper Ivy-League ideological training can immediately recognize that GATA is for mediocre white (read: uncool, not diverse) people who reside within the Ron Paul/Lew Rockwell ghetto and have ridiculously shitty standards for graphic design. These losers can not possibly prevail against Goldman Sachs or Obama or Paul Krugman or the New York Times. Even if what they are saying is true, they lack legitimacy. Why do you take them seriously?

April 6, 2010 at 7:23 PM  
Anonymous zanon said...

Sam: JKH is in comments only. He totally understands bank operations and is always correct. Other than that he is mystery.

Mencius this mercantilism is correct and believes that what matters most to country is accumulation of gold. He cannot get his head around macro, and so is stuck in micro-mode equating State with Corporation, both focused on profit, which he thinks should be counted in kilos of gold.

All sane people see that "profit" at nation level is availability of real goods and services to consumes, not any currency. But he is goldbug and there is no hopes.

ANONYMOUS: Please pick better name. Academic macro believes that money is exogenous, banks loan out reserves, and does not understand accounting. This makes it the same as Austrianism, except austrianism is clear while academic macro is bury is gooblegook. Monetarism introduces ridiculous interest rate mechanism, while keynesianism (text book) is rooted in 1920s economy and never abstracted up to balance sheet mechanisms you need to apply it with intelligence to today.

Austrianism, monetarism, and keynesinianism are all pretty similar actually -- just like republicans and democrats are just two different flavors of progressive.

April 6, 2010 at 9:27 PM  
Anonymous Sam said...

zanon,

Thanks again.

Where can one find most of JKH's comments? Any blogs in particular?

Interesting that you bring up Mencius and mercantilism. Considering his Austrian take on economics, it's strange that Mencius favors mercantilism since the Austrian school is opposed to mercantilism. I think Mises, Rothbard, et al argued that mercantilism was an economic fallacy.

I suppose Mencius could be motivated by politics, rather than the objective economics, in favoring mercantilism. He's praised the politics and form of government of the mercantilist era, so perhaps he believes that mercantilism is conducive to this political arrangement he favors and considers his top priority above economic concerns. I get this sense from reading Austrians in general though. It's hard to tell how objective and impartial they are in approaching the economics and whether or not they're just really wishing the economics were that way.

April 6, 2010 at 11:15 PM  
Anonymous josh said...

My reading of Mencius is that he sees the government as a profit-maximizing corporation as a means to obtaining the end you state, ie more good stuff for the inhabitants of the state.

That the government is a corporation is true by definition. That profit maximizing would better serve inhabitants than whatever is the MO of our various governments is at least debatable. That truly profit maximizing government would not want to be paid in pieces of paper it issues itself seems plausible.

Of course, in order for this to matter, somebody would need to own the United States the way Jefferson owned Monticello.

April 7, 2010 at 4:55 AM  
Anonymous zanon said...

Sam: JKH has comments at mosler, billy blog, and sometimes interfluidity.

Josh: An sovereign entity that can issue currency has no need of that currency for itself (why would it?) Purpose of currency is for the sovereign to get its private sector as much productive as poassibel. Sovereign then takes its cut of real output.

Prudent sovereign manages currency to maximize real output. The 10% of unemploy we have today is wasteful and bad management by sovereign

April 7, 2010 at 7:54 AM  
Anonymous josh said...

Thomas Jefferson would take his cut either in direct output or in whatever he could exchange for stuff he wanted from other plantations. Why would a natural currency not develop? If money is, in fact, a coordination game, and the bubble that doesn't need to pop, etc. then the world ought to converge on a commodity driving up its value. The sovereign would tax in this because it doesn't have the bury the corpse problem and he could buy the Burgundy he got addicted to while he was banging his chambermaids in France, no?

If Jefferson can still maintain a local fiat currency to manage who's making what, would he? Why does the natural supply and demand for investment with a fixed supply of currency not work as a price signal? What does Jefferson know that the market doesn't about who should be doing what?

What am I getting wrong. I'm sure it is plenty.

April 7, 2010 at 9:17 AM  
Anonymous zanon said...

josh: ah yes, the "natural money coordination game story" as beloved by libertarians and academics alike.

I am not interested in discussing history of money. Point is how it works and what it allows you to do (or not).

A country can run with endogenous money system (US) or exogenous money system (Greece) or a mix (any third would country). They just give you different options, with endogenous money system giving you the most.

Anyway, you have shifted from discussion of private sector credit to public sector credit. Mosler etc have good discussion of this and you can learn more there.

I will leave you wit this: Govt does not tax in order to spend, it spends in order to give us money to save and pay taxes.

April 7, 2010 at 10:02 AM  
Anonymous Anonymous said...

Off-topic, but relevant. A Canadian journalist realizes intuitively the historical origins of the campus left:

While politically correct campus activists often come across as smug and single-minded, I realized, their intellectual life might more accurately be described as bipolar -- combining an ecstatic self-conception as high priestesses who pronounce upon the racist sins of our society, alongside extravagant self-mortification in regard to their own fallen state.

April 7, 2010 at 10:34 AM  
Blogger alexi de sadesky said...

Zanon,

Thanks for pointing this stuff out. Are there any books you would recommend?

April 7, 2010 at 2:21 PM  
Blogger TGGP said...

Mencius writing seems similar in ways to both Keynes and sociologists.

David Mills didn't look that black to me in the photo.

Banking has been in something like it's current form well before Mises was born. I doubt he was the first to make that argument. Not that I know so for a fact.

In the previous thread I linked a number of posts from Bill Woolsey explaining various topics in monetary economics. Presumably that thread isn't being read now, which is why I reference it here.

"transforming maturity in gold and/or silver. This is why they're called "banks.""
So would you say banking period is harmful?

"Because there is only one reason why a party holds a CDS. They have government permission to overvalue these securities on their balance sheets."
We should be able to test that theory by examining whether people hold them under different policy regimes. It of course raises the question of what the government is doing to shift the focus onto a "balance sheet" (which should be ignored by the market if it is not representative).

"there is little or no demand for X * Q * Y. For instance, if you buy an IBM bond and an AIG CDS against it, you have replaced your exposure to an IBM default with exposure to an AIG default."
IBM is particularly unlikely to go bankrupt, but there are many possible firms whose default you could insure against who are less stable than their insurers.

"In reality, no party (except USG) is really so much more financially secure than IBM"
In the eyes of the market, USG is about the equal of Campbells and below Warren Buffet. Casey Mulligan views this development as a good thing.

"incorrect accounting principles allow them to"
What's this "allow them to" business? You have to explain in terms of incentives, or demand. Has anyone ever cashed in a CDS without thanks to a government bailout?


Anonymous Afrikaaner sympathizer:
One common version of the story is that he died because of a dispute with some of his employees. Since he had previously been charged with attempted murder, it's not far-fetched to think his behaviour (and not merely expressed beliefs) was a factor.


Mitchell:
Voltaire certainly did not favor monarchy. He was the court intellectual of enlightened autocrats. He was on the side of the modernizing, centralizing power against the old feudal privileges & provincialism (as were many rationalists).

April 7, 2010 at 8:14 PM  
Blogger TGGP said...

Ursus:
"Are we already in a period of hyperinflation masked by every currency hyper-inflating at similar rates?"
How are prices of most commodities faring?

Unlike pretty much every Keynesian today, Keynes himself did not favor counter-cyclical fiscal policy. He favored the socialization of investment, but his secular argument was rejected as too radical and reframed as a cyclical argument.


zanon:
So in the absence of government debt, saving is impossible? It's trivial to show this is wrong in terms of real wealth, and P.Ks emphasize they are talking about a world with fiat money, but the real hasn't been abolished.


Michael S:
John T. Flynn said basically the same thing in "As We Go Marching". As John Wood showed, that's true for more people than just Keynes.


Macroeconomics is fairly commonly regarded as the "ugly sister" to microeconomics. I'm generally suspicious of attempts to use two theories rather than one (hence my partiality to the economics of Szasz), so like the Austrians I'm bitter about Keynes helping to split economics into micro and macro. And of course I'm a thoroughgoing reductionist, making me sympathetic to Lucas' insinstence on microfoundations, not surprisingly putting me at odds with John Holbo. I suppose this reveals my ignorance of macro, but I generally just try to think in Chicago-style micro terms. Free-banking can be thought of as just applying supply & demand econ to money & credit as you would anything else, so that's where my sympathies lie. Friedrich Hayek's notion of the "fatal conceit" also lies behind my distaste for the Rothbardian insistence on the One True Form of Banking preached by Mencius.
A little while ago I found an interesting paper from the 80s about the distinction of the old Marshallian Chicago School (typified by Milton Friedman) and the newer Walrasians such as Lucas & Sargent, which later gave birth to the dreaded Real Business Cycle theorists. The author suggests that these new Walrasians (the former had been mostly socialists, except for the conservative Schumpeter who wasn't that mathematical either) have many similarities with the Austrians, which perhaps shouldn't be surprising since Marshall never completely joined in the marginalist revolution spearheaded by Menger & Walras (plus Jevons, who had no real disciples). Just as I abhor the Austrian methodology, I find that Friedman comes off looking a lot better in that paper due to the greater importance he places on empiricism, even if we ideally would want the more general theory explainable in real terms of the Walrasians.

April 7, 2010 at 8:16 PM  
Blogger TGGP said...

As best I can recollect, Mencius has acknowledged the existence of P.Ks a grand total of one time (when he said they, along with Austrians and mainstream economists may all be crackpots). I have asked him to give his thoughts on them, but I don't think he's that interested. I did the same for Scott Sumner, but he said it was enough of a chore to read up on Austrian economics and argue with his commenters of that persuasion.


zanon:
Scott Sumner is something of a neo-monetarist and bashes Keynesians (including Post Keynesians like Joan Robinson) for their fixation on interest rates! He agrees though that old Keynesianism was meant for a gold standard economy.


Sam:
Mencius has not explicitly advocated mercantilist trade policies, though it wouldn't be surprising if he was really going drop libertarianism for reactionary monarchism. Mencius imbibes his goldbuggery from the Murray Rothbard (and questionably Mises) strand of Austrian economics. Austrians are of course free-traders, though a number of paleo types (Garet Garret, Paul Craig Roberts, Pat Buchanan, sometimes Sailer) are protectionists.


josh:
"more good stuff for the inhabitants of the state."
No, for the OWNERS of the state. He happens to think that will tend to align interests with the inhabitants.

April 7, 2010 at 8:16 PM  
Anonymous Jeff65 said...

"So in the absence of government debt, saving is impossible? It's trivial to show this is wrong in terms of real wealth, and P.Ks emphasize they are talking about a world with fiat money, but the real hasn't been abolished."

In the absence of government deficits, saving that which is needed to pay taxes is impossible. The real world needs to pay taxes. And real wealth is taxed which forces some of it to be monetized.

April 7, 2010 at 8:56 PM  
Anonymous Sam said...

TGGP,

Mencius appears to advocate mercantilism here:

http://www.interfluidity.com/v2/540.html#comment-4400

It's interesting that he mentions Friedrich List and his book "National System of Political Economy" since List was one of the forefathers of the German Historical School of Economics which was a rival of the early Austrian School economists. The German Historical School and the Austrians apparently had a major debate over methodology, with the Historical School favoring empiricism, historicism, etc., as opposed to the deductive, logical method of the Austrians. One would think that Mencius, as an Austrian and someone who has criticized statistics, inductive science, etc., several times, would eschew mercantilism and the work of people like List.

April 7, 2010 at 8:58 PM  
Anonymous Jeff65 said...

I'm not always a fan, but I always thought Karl Denninger's analysis of CDS's as a complete scam was convincing. Skip the rant and start after the line "Simply put Mr. President...":

http://market-ticker.denninger.net/archives/932-Wheres-My-Pitchfork.html

The punch line is that in an efficient market low risk bonds must yield more than high risk bonds plus purchase of CDS. If risk pricing is functioning correctly, the CDS writer must charge more for the CDS than the spread between the yields of the two bonds.

April 7, 2010 at 10:08 PM  
Anonymous josh said...

TGGP:

josh:
""more good stuff for the inhabitants of the state."
No, for the OWNERS of the state. He happens to think that will tend to align interests with the inhabitants."

That's what I said.

"as a MEANS to obtaining the end you state, ie more good stuff for the inhabitants of the state."

April 8, 2010 at 4:56 AM  
Anonymous zanon said...

TGGP:

Bill Woosley and Scott Sumner are the idiots, with Woosley being more MORONIC that Sumner, but Sumner being overall more pathetic. If you want to witness to ridiculous farce that is monetarism however, I cannot think of a better exhibit A and exhibit B.

It is correct that private sector cannot have positive net financial savings without Government being in debt. It can have positive real savings but of course. Both are important.

I have never seen anyone get good macro beginner from micro-foundation. Micro is not careful enough about stock/flow and accounting (it does not need to be) but this is critical for Macro

April 8, 2010 at 8:05 AM  
Blogger River Cocytus said...

zanon: Though to what extent and how directly the government is 'spending to give us money to save / pay in taxes' is in question.

Clearly providing for national defense, internal peace and certain regulations is money spent on civil servants who permit the oeconomy to function to generate revenue for them.

But I think the logic applies only to them: This is not the 'reality' - and I believe that if they take this thinking to its greatest extreme - that is, 100% planned oeconomy, where (more or less) they determine who gets money and why to save or spend, you must necessarily break the oeconomy.

I think it is succinct to simply say that there are at least four kinds of logic employed which are in effect 'aboriginal objects excluding one another' who will either war against, negotiate with or eliminate one another. The extension of government thinking to all spheres - effectively destroys the 'rules of the house' as it were.

The logic of the market, the church and the community are naturally at odds with that of the government (and each other.) Harmonizing them is an important task, but it is not one that a government can do, except be itself in harmony with the others as best as it can. If it attempts to harmonize the others, it does so by making them into itself.

April 8, 2010 at 8:57 AM  
Anonymous Michael S. said...

On the issue of MM's advocacy of mercantilism, I'd point out that he has described his favored system of political economy as "neocameralism."

The original cameralists - without the "neo" - were economists from Austria, if not "Austrian economists." They antedated Bohm-Bawerk & Co. by about 200 years. Important names are Philipp von Hornigk, Johann Joachim Becher, and Wilhelm von Schröder. Schröder's book "Fürstliche Schatz- und Rentkammer" is one of the founding texts of mercantilism.

April 8, 2010 at 11:09 AM  
Blogger Mitchell said...

Off-topic: the manifesto of Hungary's "far right" party, Jobbik. Rather tame for this blog. Jobbik helped to found a new pan-European alliance of similar parties last year.

April 9, 2010 at 4:54 AM  
Blogger joshuaamayes said...

Zanon --

"It is correct that private sector cannot have positive net financial savings without Government being in debt."

No, it isn't. There is no reason the USG can't simply mark up reserve accounts without noting a debt on its books. USG doesn't need to take on any debt at all, ever. It can mark up the account of whomever it wants just by adding some zeros to an account at the fed. This would be the modern equivalent of running the printing press. The only reason it doesn't do so (i.e., monetize the national debt) is because inflation would skyrocket, and the dollar would be massively devalued.

Perhaps you just meant "deficit" instead of debt, in which case you would be sort-of correct from a strictly accounting perspective. Anytime the government increases someone's reserve account it is called government spending. You can't have a net increase in private sector reserve account balances without taxing less than this spending, essentially by definition. In reality, though, this is no different than saying there can't be a net increase in the number of dollars in the private sector without dollars being printed by the USG.

This is true, but this type of paper "net increase in savings" doesn't translate into increased actual purchasing power held in reserve by the private sector. In essence, it is simply monetary inflation. Only efficiency gains and actual production can result in real increases in private sector purchasing power, and that is what matters for our standard of living, not how many zeros are on the tail end of private sector accounts at the fed. If you measure in real private sector savings (i.e., purchasing power) rather than paper private sector savings (i.e, bank account balances), you don't need a deficit to increase savings.

You essentially acknowledge this when you say "It can have positive real savings but of course."

But you are just wrong when you say "Both are important." I could care less whether my work nets me $1, $10 or an ounce of gold, if each bought the same loaf of bread.

April 9, 2010 at 12:40 PM  
Anonymous zanon said...

joshuaamayes: Govt spends exactly as you say, it just marks up private sector account (asset).

But it also does double entry bookkeeping correctly and marks up a liability in its own book.

Debt issuing is change in term structure of outstanding govt liability. Taxation is opposite spending, it is just marking down book. Neither are for "funding" the spending (at Federal level).

Debt is stock. Deficit is flow. Sum of all deficits is debt.

Whether deficit ends up being inflationary depends on whether new money is saved. If saved, there is no inflation effect (although there is more inflation bias).

Financial assets are important because insufficient net private savings causes unemployment, which reduces real output. 10% unemployment rate today is exhibit A.

April 9, 2010 at 1:39 PM  
Blogger TGGP said...

Possible commonalities between Austrian & Keynesian economics are being discussed here. I would link to the Post-Austrian Economics blog on that, but it cannot even be found on the Internet Archive. A number of Austrians seem partial to Axel Leijonhufvud, and even though Boettke says it was the Austrians biggest mistake to bet on Axel rather than Bob Lucas, they still seem to promote him frequently and in contrast to "freshwater" economists.

April 10, 2010 at 9:37 AM  
Anonymous Alex said...

You should look at combined options and futures open interest:
http://www.cftc.gov/dea/options/other_sof.htm

this tells you that on the CME, commercial hedgers are short, money managers (incl index funds) are long along with small specs. But sine paper positions (ie unreported ISDA swaps) aren't tallied none of these figures means too much. I suspect your friend is correct that banks don't hold large enough open short positions to impact price direction.

I think you're neglecting a couple of things about CDSes. Default risk is indeed an issue, but less so when a CDS market is well diversified. A company with no material exposure to IBM (maybe one with inverse financial interests) might be in a perfect position to insure IBM debt, maybe a lot better than the US government (which recent actions notwithstanding does NOT guarantee the majority of CDS agreements worldwide.)

April 11, 2010 at 5:41 AM  
Anonymous Bob said...

Liberal biorealist has a new post up.

http://liberalbiorealism.wordpress.com/

April 11, 2010 at 10:10 PM  
Blogger Alex said...

Basically, it means that these governments are surreptitiously using (and, inevitably, consuming) their gold reserves

No one "consumes" gold reserves - a major distinction between non-industrial precious metals and other commodities. Thus there are no "natural shorts" -- only natural longs. Gold leasing is merely a way for banks and ETFs to offset their holding costs (warehouse fees, insurance, cost of capital) in exactly the same way that bonds are financed in the repo market and currencies in the "tom/next" market.

You might call this commonplace vehicle "maturity transformation" but to most it's simply a "collateralized loan." gold is not a consumable good like oil, wheat, or platinum, nor a service; it has no convenience yield, and leasing it out doesn't impact the total market inventory. Further only a small fraction of the world's bullion is somehow enough to hold the entire market in contango through leasing (at record low lease rates, it should be said). OECD lease volumes are limited by CBGA-1 and -2 to 1999 levels (a meager 2k tons total).

One way to see whether bullion banks are short is to look at the levels of gold in Comex vaults. Currently they stand at all time *highs* of 10m oz., 10% above last year, continuing an almost uninterrupted 10 year climb. Lease rates are very close to zero (1.5 basis pts, having spent the bulk of 2009 in negative territory, implying a major oversupply of physical commodity versus forward positions.)

There is a name for an entity which holds long forward positions in gold: a bullion bank. Ordinary large investors, when they hold gold, seem to generally hold futures

beyond collateral applied to mark to market, there is no functional difference between a future and a swap/forward. Hedge funds and other fin specs do indeed hold gold swaps , enough to induce CME to list them on clearport:

http://www.cmegroup.com/trading/metals/files/LondonGoldForwardSS.PDF

April 12, 2010 at 2:27 AM  
Blogger joshuaamayes said...

Zanon:

"But it also does double entry bookkeeping correctly and marks up a liability in its own book."

But it doesn't *need* to do this. It does it to keep inflation under control.

"Debt issuing is change in term structure of outstanding govt liability."

Debt issuances are promises to increase a particular reserve account in the future, plus interest, in exchange for decreasing the account now. I think this is what you mean.

"Taxation is opposite spending, it is just marking down book. Neither are for "funding" the spending (at Federal level)."

Yes, but so what.

"Debt is stock. Deficit is flow. Sum of all deficits is debt."

This is wrong. Debt is a promise to increase a reserve account in the future. Deficit is the difference between government spending and taxation. There is no necessary correlation between debt and deficit. In other words, deficit does not need to be added to the debt stock; it can be monetized. The government could fund all of its spending by marking up reserve accounts, without any taxation or debt issuance whatsoever. It doesn't do this, because it needs taxation to create a demand for USG dollars (as opposed to gold or something else) so that USG can buy things, and it issues debt to control inflation.


"Financial assets are important because insufficient net private savings causes unemployment, which reduces real output."

This is quite an extraordinary empirical claim, and I do not believe it to be true. Unemployment is undoubtedly caused by a host of factors, and the amount of private sector savings is likely one of them. *Real* private sector savings, that is. I will not believe, without some empirical proof, that private sector businesses lay off workers and fail to grow because they have insufficient *paper* savings and that unemployment can be erased with a swipe of the inflationary pen at the fed.

April 12, 2010 at 10:45 AM  
Blogger Bill said...

"And so far as I'm aware, all priority is due to Mises (1912"

You have obviously never heard of Otto Hübner, who coined the phrase "Goldene Bankregel" (golden rule of banking) in his book "Die Banken" published in 1854.

The golden rule of banking basically says that the maturity of banks' assets should always match the maturity of their liabilities. As far as I know, in the German speaking world, this "rule" is one of the first things taught in any university course on money and banking, so it's hardly a revolutionary or novel concept. Of course, the next step is to learn a list of reasons (all dubious) why the rule no longer applies in our modern world. As Bastiat put it:

"When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it."

April 13, 2010 at 3:11 AM  
Anonymous zanon said...

joshuaamayes: what i am saying is simple and accurate description of actual operations and accounting of govt financial actions.

economists of all sorts -- austrians, monetarists, keynesians -- cannot be bothered with thing as mundane as double entry bookkeeping and operational reality, so construct all kinds of pie-in-sky theories and models that having nothing to do with real life.

It is up to you if you want to bother with understanding how system actually works, and thus understand exactly why academic economists have been selling you load of crap. Plenty of links on this thread to get you started if you want to learn something new.

But since you do not understand stock/flow, and believe that accurate record keeping has an effect on inflation, I have no hopes for you. Keep bowing to your Austrian masters!!!

April 13, 2010 at 11:41 AM  
Blogger joshuaamayes said...

Zanon:

Are you reading my comments? If so, you are not understanding them. I am clearly not an Austrian. Indeed, I haven't fully formed my views about proper monetary policy, and I may never take the time to do so, because it would require quite a lot of work, and I have a real world job. Intuitively, it seems that consistent, mild inflation might be good for the real economy. But it is an empirical question, and I don't have enough evidence to make a decision about it. Generally, in the absence of evidence, I prefer less intervention by governments (based on the proven track record of incompetence). Even if some level of inflation is desirable, I have little confidence in USG identifying the optimal amount and then implementing monetary policies to reach that goal effectively. This too, is an empirical question. Thus, I might ultimately favor an asset-backed currency if I thought about it more, but not for the reasons the Austrians do.

Federal reserve accounting is not so arcane or difficult to comprehend as you like to imply. I gues it makes you feel smart. But, like those you are criticizing, your comments appear to be based on theory (and mainly just accounting theory, at that), not empirical evidence.

In any event, I understand quite well how the fed works, how the fed balances its books, and how the reserve system functions. I understand double entry accounting, and I understand stocks and flows.

My point, however, is that once a floating currency came into existence, double entry book keeping at the sovereign level is simply an unnecessary anachronism. It is not *necessary* for the fed to balance its books. The accounting by which outstanding dollars held by the private sector are recorded as a liability on the fed's book, doesn't make this a "debt" in any meaningful sense of the word. Instead, it is a throwback to the time when federal reserve notes could be redeemed in gold. The law stating that reserve notes are "obligations" of USG may still on the books, but after the gold standard was eliminated, it is meaningless.


When I use the term "debt," I (as well as most English speakers) mean it in its commonly understood sense -- an obligation to make a payment at a certain time in the future. USG does issue this kind of debt (i.e., treasuries).

In short, you're treating all issued dollars as USG debt (per the accounting convention), and your position is literally true, but nothing more than sophistry based on an outdated mode of accounting. The stock of government debt (in the my sense) is important because it will require either taxes or monetary inflation in the future. Both of those have demonstrable effects on incentives and wealth creation in the historical record.

The additional stock of debt in your sense (i.e., including all outstanding dollars) is largely irrelevant. On a going forward basis, only the flows matter, because they represent monetary inflation or monetary deflation.

I find it highly amusing that you seem beholden to and obsessed with double entry accounting, which is a throwback to the gold-standard era, while simultaneously you chide Austrians and Keynsians for their inability to adjust their theories from gold-based to floating currencies. Maybe we need post-post-Kensyians who can think outside the balance sheet and do some actual hands-dirty empirical work rather than spying balance sheet tautologies.

In conclusion, what matters for me in deciding proper monetary policy is its effect on *real world* incentives and *real world* wealth creation, not its effect on paper balance sheets. Calling fed reserve balances USG "debt" based on accounting anachronisms, and calling increases in paper money "savings," just doesn't advance the discussion and generates needless confusion, in my opinion.

April 13, 2010 at 1:32 PM  
Anonymous Jeff65 said...

"The stock of government debt (in the my sense) is important because it will require either taxes or monetary inflation in the future."

What was used to purchase the government debt? The answer tells you that the monetary inflation occurred in the past.

If everyone holding US Dollars who wanted to buy US Treasuries did not have the option to do so, what would they do? I think it's ridiculous to presume that 99% would hold anything riskier than US Treasuries and even more ridiculous to presume they'd go on an inflationary spending spree. The most likely option would be to hold the US Dollars they already have.

The problem is that government debt is issued in the form of other debts, but it is nothing like other debts. It is much more like a government sponsored, interest bearing alternative to holding cash.

April 13, 2010 at 7:35 PM  
Blogger Minitrue said...

"What was used to purchase the government debt? The answer tells you that the monetary inflation occurred in the past."

The debt purchase consisted of reducing reserve account balances. That reduced the money supply by taking purchasing power out of the hands of the (now) debt holders. Treasuries cannot be spent, but dollars in reserve accounts can be. The debt is a promise to refund the accounts in the future by a larger amount. If that future spending is offset by taxes or further debt purchases, it will not be inflationary. If not, it will debase the dollar.

To the extent that there were enough dollars in circulation for treasuries to be purchased, this may or may not be a result of past inflation. In any event, past inflation is sunk and shouldn't impact optimal monetary policy on a going forward basis.

"The most likely option would be to hold the US Dollars they already have."

Only if they were fools. Once it became clear that the USG was monetizing its debt, smart money would flee the dollar and head for a foreign currency, a commodity or other safe haven. This would not be an inflationary spending spree, it would be a rational reaction to the increased supply of spendable dollars flooding into the reserve system.

" It is much more like a government sponsored, interest bearing alternative to holding cash."

No, it isn't. Because cash and reserve account balances can be spent at any time. Treasury notes and bonds don't mature for years or decades. The principal is transparently removed from the system and cannot be spent for that entire term. This is critical to controlling monetary inflation.

April 13, 2010 at 8:32 PM  
Anonymous Jeff65 said...

"This is critical to controlling monetary inflation."

While technically true, buyers of treasuries are looking to save, not spend. This suggests US govt debt issuance is not at all critical to real inflation.

April 13, 2010 at 8:53 PM  
Blogger Minitrue said...

"While technically true, buyers of treasuries are looking to save, not spend. This suggests US govt debt issuance is not at all critical to real inflation."

Those buying treasuries are not even close to the only players in the dollar market though. Those holding and trading in dollars pay attention to the number of them in circulation. If they see a massive influx of new dollars resulting from monetization of government operating deficit or outstanding debt, they are not going to sit idly while their holdings lose value. They're going to sell dollars. It is not only desire to spend that matters; the *perception* of the total supply of dollars by market participants is equally, if not more, important.

You seem to be ignoring the effect that the transparent increase in the dollar supply will have on rational investors and currency traders. The simply is no reason to assume that the price of dollars will be unaffected by an increase in their supply. Whenever USG chances its monetary policy, it creates different incentives and a different equilibrium than the ones existing at time zero.

April 14, 2010 at 5:26 AM  
Anonymous Pals said...

Zanon,

I have continued to give you post-Keynesians a shot at making some sense. I re-read the previous threads you've posted and even followed some of the links to your semi-literate economist friends in order to figure out what the hell your deal is. Now I get it, and it is thanks to this monstrous idiocy you wrote:

"Financial assets are important because insufficient net private savings causes unemployment, which reduces real output. 10% unemployment rate today is exhibit A."

This is something dumb enough to be published in a Keynesian textbook. If this bore any relation to the truth, Zimbabwe would be the richest country in the world. Wealth and value are not generated from issuing increased claims to the same amount of stuff, they're generated from PRODUCING MORE STUFF.

The biggest scam of the past two-hundred years of western thought comes from the triumph of scoundrels who propagate this myth. You Post-Keynesian retards are no different.

Also, your childish pride with the fact that you understand how banking balance sheets work is fucking dumb. Compared to your average Keynesian, you have a slightly better grasp of reality. Compared to your average Austrians, you have a slightly better understandings of the mechanics of modern banking. This still doesn't change the fact that you're a bunch of inflationist retards who continue to believe that wealth and prosperity can come from running a printing press.

Here's the deal: you seem to think that within the current fiat money system, deflation is a bad thing and should always be fought with more inflation. You're half-correct, but you miss the point that if morons like you were in charge, you'd inflate away the fiat money system in 15 minutes.

The only reason the fiat money system happens to survive is that the dumbass monetarists and dumbass keynesians, in their infinite non-wisdom, manage to not continue to inflate as crazily as you would want.

You cannot escape the glaring fact that far better than your world or the Keynesian or Monetarist world is a world where no government can control the money supply, and money is nothing but a medium of exchange.

April 14, 2010 at 5:44 AM  
Anonymous Jeff65 said...

Minitrue,

There is no denying that the increase in the supply of dollars has already happened by the time they are spent on treasuries. The dollar liabilities already exist.

As far as the dollar market, I never said there would be no implications. That's the other side of MMT, the appropriate response to inflation is taxation. That is how the government maintains the value of the dollar.

There is zero reason for the US government to set spending policy to appease the US debt markets.

April 14, 2010 at 1:46 PM  
Anonymous Jeff65 said...

Pals,

"You cannot escape the glaring fact that far better than your world or the Keynesian or Monetarist world is a world where no government can control the money supply, and money is nothing but a medium of exchange."

That's a ridiculous statement in the context of the rest of your posting. You rant about inflation and then you fail to define money as a store of value. A medium of exchange can persist through significant inflation of its supply. Are you worried about inflation or not? If you are your definition of money is too simple.

Additionally, someone or some entity must control the money supply. Much better the government than anyone else (even though they currently do a terrible job, there is some chance of making it work for the people in the future.) Let's not fantasize about some monetary system that will take care of itself - such a thing does not exist.

And from your insulting rant at Zanon, it is clear you have only learned enough about MMT to trigger emotional responses to contradictions with Monetarist pre-conditioning. Even non-Monetarists suffer from plenty of this. The Democratic Party has swallowed it hook line and sinker.

MMT includes policies to control inflation. You must be unable to see the "T" word, similar to Minitrue.

April 14, 2010 at 2:12 PM  
Anonymous zanon said...

Jeff65:

I admire your persistence in the face of MORON. Pals in particular is potty-mouth lunk head. Do not waste your time.

I will say, though, that it is not necessary to have an entity control money supply. You can have exogenous money, and there are plenty of countries i world who have just this. Greece, and all of EU, is an examples.

Problem with exogenous money supply is 1) does not solve inflation problem (as level of monetary base is unconnected to inflation or lack thereof), and 2) offers no solution to decrease in private sector demand to net save, and associated fall in employment and real output.

So you can still get hyperinflation and you cannot handle Depression. It is step backwards.

Of course, given how badly fiat regimes are run today it is not surprising that these benefits are hidden.

April 14, 2010 at 2:38 PM  
Blogger Minitrue said...

Jeff:

"There is no denying that the increase in the supply of dollars has already happened by the time they are spent on treasuries."

Yes, there were already enough dollars in existence to buy the treasuries. But USG sells the treasuries to offset what would otherwise be the inflationary effect of deficit spending.

"That's the other side of MMT, the appropriate response to inflation is taxation. That is how the government maintains the value of the dollar."


Here is what I wrote in my earlier comment "If that future spending is offset by taxes or further debt purchases, it will not be inflationary. If not, it will debase the dollar." I recognize that taxation can also be used to control inflation. But taxation really messes up private sector incentives and stifles growth. That proposition has a lot of empirical support, and it is a good reason to control inflation by issuing debt or cutting spending rather than by raising taxes.

April 14, 2010 at 3:38 PM  
Anonymous Jeff65 said...

"But taxation really messes up private sector incentives and stifles growth."

I agree about the potential for incentives problems, but I wouldn't dismiss all taxation on those grounds. I don't understand the second issue - I thought stifling growth and controlling inflation were the same thing!

If you can't draw a distinct line between stifling growth and controlling inflation, I'm inclined to regard it as an excuse for maintaining the status quo.

One of your favored remedies, reducing government spending, also stifles growth. There isn't really much material difference between "more taxes" and "less spending" aside from who each impacts. Less govt spending as it is practiced now most affects those who can least afford it. If we could stand that on its head I might favor less govt spending as an approach.

April 14, 2010 at 8:52 PM  
Blogger Minitrue said...

Jeff:

"I don't understand the second issue - I thought stifling growth and controlling inflation were the same thing!"

I'm talking about *real* growth in that sentence, not paper growth. The US economy grew enormously with little inflation under the gold standard; paper growth and real growth are completely separate. I feel like you MMT disciples continually ignore the real and focus solely on paper.

Taxes encourage the private sector to produce less real output.

"reducing government spending, also stifles growth"

This is not true. Government spending will often stifle real growth in practice. The government frequently creates monopolies or monopsonies when it spends, which not only create deadweight loss, they reduces innovation. And government spending also screws up incentives in the private sector.


"There isn't really much material difference between "more taxes" and "less spending" aside from who each impacts."

Your "aside" is hugely important. The government is awful at spending in a way that creates wealth, produces innovation and identifies efficiencies; the private sector is excellent at it. You can't seriously challenge that as an empirical matter, and it makes all the difference in the world.

April 15, 2010 at 6:53 AM  
Anonymous zanon said...

Minitrue: Fed Treasury issuance has no impact on inflation as it does not "sterilize" outstanding monetary base in fiat regime. Monetarists will cry at this, but their transmission mechanism (the money multiplier where banks lend out excess reserves) simply does not exists. Banks do not lend out reserves (as per monetarists) just as they do not lend out deposits (as per austrians).

Point of Treasury issuance is to maintain federal funds rate above zero. In our current ZIRP environment, Treasury could just stop issuing them and it would have no effect.

Inflation is caused by prices being bid up. Increasing quantity of outstanding Govt liability can increase inflation bias (but may or may not cause inflation). Composition of outstanding liabilities really has no impact. There is no interest rate lever.

Optimal taxation policy in correctly run fiat regime is very interesting, and quite different from standard micro texts which assume goal is to raise revenue. Taxation to control inflation is different animals.

April 15, 2010 at 10:46 AM  
Blogger jimbo said...

Let me second Zanon, here.

An exogenous money supply can work, for a long period. But it can't really avoid a hyperinflation, since hyperinflation is caused by major supply shocks (like the shuttering of most of Weimar Germany's industrial base by the allies in the early 20s and the liquidation of the the white-controlled agricultural and industrial sectors in Zimbabwe under Mugabe.) If 50% of your economy disappears, prices are going to get bid up.

And it can't deal with ha demand shock, either - when savings desires increase drastically, there is no to step in and provide the savings, so economic activity decreases until supply equals demand.

But of course, in our modern world we have governments running fiat regimes who either don't know they are or are convinced that allowing the fact to be uttered in polite company would be a disaster of Biblical proportions - so instead of proactive policies to create full employment, we are forced to depend on the automatic stabilizers.

That's better than nothing - the deficits seem to be starting to turn the ship around as we speak - but it still leaves a lot of people in misery, even in "boom" times...

April 15, 2010 at 11:08 AM  
Blogger jimbo said...

"But USG sells the treasuries to offset what would otherwise be the inflationary effect of deficit spending."

As per Zanon (again), this is incorrect. The inflationary impact of the deficit is in it's addition of net financial assets to the private sector. Selling Treasuries has no impact on net private sector assets; all it does is change the term structure of interest rates. There is no functional difference, other than rate of interest, between reserves and Treasury securities in a fiat system.

April 15, 2010 at 11:13 AM  
Anonymous Jeff65 said...

Minitrue,

Your last message is full of factual assertions that are not fact. I'll ignore most of them to concentrate on this whopper:

"Your "aside" is hugely important. The government is awful at spending in a way that creates wealth, produces innovation and identifies efficiencies; the private sector is excellent at it. You can't seriously challenge that as an empirical matter, and it makes all the difference in the world."

This is easily challenged. The GFC is a private sector debacle. Governments may have enabled the behavior through lack of oversight, but that was only the rope. The big banks hung themselves with it and then held the economy to ransom.

April 15, 2010 at 2:01 PM  
Anonymous Anonymous said...

You mean those little squares you use to make chicken soup?

April 15, 2010 at 2:23 PM  
Blogger Minitrue said...

Jeff:

"This is easily challenged. The GFC is a private sector debacle. Governments may have enabled the behavior through lack of oversight, but that was only the rope. The big banks hung themselves with it and then held the economy to ransom."

I'll refute your point like this:

USSR v. USA; China in the 70's v. China today; California v. Texas. If you honestly believe that the government sector is better at creating wealth than the private sector, well, I don't know what else I can say.

But yeah, sometimes private sector actors screw up. And for some reason, all those layers of regulators don't seem to stop it. We must need more regulators.

April 15, 2010 at 2:36 PM  
Blogger Minitrue said...

Jimbo:

"There is no functional difference, other than rate of interest, between reserves and Treasury securities in a fiat system."

There is a big difference; treasuries notes and bonds mature years or decades in the future. That principal cannot be spent; it is transparently removed from the spendable money supply. People pay attention to the spendable money supply. If the fed announced tomorrow that it was cashing out all treasuries by marking up reserve accounts, do you actually believe the dollar would hold its value? Smart money would run like hell.

April 15, 2010 at 2:44 PM  
Anonymous Jeff65 said...

Minitrue,

The treasury maturities don't matter. For all intents and purposes they cash equivalents due to the existence of an enormous secondary market. Anyone holding treasuries is not the least bit constrained from spending the money tied up in them if they want to do so. They can sell the treasuries or they can borrow against these treasuries and spend right now.

Your logic suggests that the mere availability of treasuries reverses savings preferences. This is not a credible claim.

I'd like to know where you believe the smart money would run? Treasuries are for the risk averse. Aside from USD there is no other market that could absorb the flow. Our major trading partners would never allow the USD to fall as much as would be required for the disaster you imagine because it would kill them too. Seriously, you haven't thought this through.

April 15, 2010 at 3:48 PM  
Anonymous Jeff65 said...

Minitrue,

"USSR v. USA; China in the 70's v. China today; California v. Texas."

Once we examined the actual proposals for govt spending advocated by MMT, we would see that they are nothing like the examples you've given here so this is a non-argument.

The government = bad, private sector = good premise is not good enough anymore. The government in a democracy is supposed to be "we the people". Instead of bitching about it demand that it is fixed.

April 15, 2010 at 4:00 PM  
Anonymous zanon said...

Minitrue: Jimbo is correct, if US Govt stopped issuing new Treasuries, all that would happen is spending would pile up in reserve accounts instead.

If you look at US reserve position today compared to past, you will see it is much much larger. I forget exact figures, but order of magnitude may be correct.

And yet we see interest rate very low. Smart money is staying put. Same argument in japan, where smart money has stayed put now for 30 odd years. Monetarists and Austrians both believe that, given US Gov balance sheet today, interest rates should be very high, but they are not. So, they fall back to "hyper inflation is juuust around corner now!" They cannot conceive of 20 year style Japan stagnation.

Jeff: I will admit I do not love MMT spending proposals, as I see them as naive to extreme. That said, you are correct in that MMT does not mean big Govt spending. Whether you choose state directed investment or private sector directed investment is independent of how you choose to run currency regime. Private sector credit, in all cases, is not truly private.

April 15, 2010 at 6:21 PM  
Blogger Porphyrogenitus said...

"The government in a democracy is supposed to be "we the people". Instead of bitching about it demand that it is fixed."

Um, not that I think he's right about evertything, but have you read any of Moldbug's non-economic posts?

Perhaps then even if you don't end up convinced he's right, you might not be so sure it's as easy as all that.

"Democracy will fix it!" - Hair of the dog? After all, it's been so good at fixing these banking crises that since FDR we don't have them anymore.

(I also have to admit I was amused seeing that posted as a comment in one of the internet's foremost anti-democracy blogs. "A new era of LoLs").

April 15, 2010 at 7:42 PM  
Anonymous Jeff65 said...

'"Democracy will fix it!" - Hair of the dog?'

Any significant change of trajectory assumes a great deal. Why not aim high?

The real change needed is political accountability to citizens and good governance. If we can't assume those things (even though I agree we've never had them) everything else is pissing in the wind.

April 15, 2010 at 7:56 PM  
Blogger TGGP said...

Larry Bartels has a great paper on the "hair of the dog":
http://www.henryfarrell.net/polsci/2007/08/achen_and_bartels_on_the_democ.html

April 15, 2010 at 8:42 PM  
Anonymous zanon said...

jeff65:

i do not knows how familiar you are with this blog, but it is to the democracy what MMT is to moronic monetarism (and austrian!)

coming here and talking about the peoples is like going to mosler and talking about money multiplier

April 15, 2010 at 10:45 PM  
Anonymous Jeff65 said...

zanon,

I recall reading MM claiming to be a Jacobite. Is there a short post where he declares what this means in a modern context? You mention Bill Mitchell going on and on - he's got nothing on MM!

I just thought MM enjoyed being an anachronism because it made for interesting discussion. I was never certain he advocated it as serious policy but then I can't manage to get through an entire post...

I'm as skeptical as anyone about attaining a functioning democracy, but we might be able to make some modest improvements if people understood how the monetary system works. Obama is in danger of becoming the next Herbert Hoover. And there is no good reason he should, but it appears he may listen to the wrong people anyway. Everyone else will get to suffer...

April 15, 2010 at 11:51 PM  
Anonymous josh said...

"I'm as skeptical as anyone about attaining a functioning democracy, but we might be able to make some modest improvements if people understood how the monetary system works."

Your second sentence disproves your first. There are reasons everyone believes nonsense.

April 16, 2010 at 4:39 AM  
Anonymous josh said...

Make that "the second part of your sentence"

April 16, 2010 at 6:30 AM  
Blogger Porphyrogenitus said...

One of the problems is there is no way Obama or any other President or political leader in our system is going to wake up one morning and realize that everything they're doing is fundamentally flawed.

They're surrounded by a coterie of like-minded people who they brought with them to power and who brought him with them to power. That's why the most sensible descriptive term we use for anything done or decided by the executive branch is never "The President's Policy is", it's "The Administration's Policy is".

These guys and gals listen to each other, the information inputs in the daily brief come from each other and sources they trust (which certainly aren't sources we consider credible on the economy or much else).

We could go out and do our democratic duty to try to stear them to wisdom. At best that might mean informing the circle of all Tea Party-inclined people on economics, and get them and their friends and whomsoever else we can convince to go out and start protesting for a sound monetary, financial, and economic policy. Which some do, or some think they do (they might be misinformed, but we might not be fully right, either. Note that we can't be because even among the sample of all commenters on UR, agreement is at best incomplete).

But this Pharoah will harden his heart. He will not listen, because those aren't the droids he's looking for.

Some other, future head of government might. But if you think we're headed for Hooverville unless The Adminstration completely reconceives the economic theory that underlays their policy, it simply won't happen.

Yes in theory Obama or any other President could fire all his own appointees and restaff the entire administration with people like Thomas Sowell, Walter E Williams, the fine people at the Mises Institute. (That is assuming you think they offer something closer to a workable economic theory). There might be just enough of them to fully staff all the offices Obama can fill.

This Congress won't approve them, though. (Obama wakes up from his stupor and becomes a fan of Austrian Economics, fires his staff, dissassociates himself from anything ever said by the likes of Paul Krugman, and Harry Reid and his minions in the Senate do what? Nod in unison)?

Even if that were to happen - partisan loyalty to the President is so fanatical that even when he Goes Rogue, they go with him, you're still touching only a fragment of the goverment. All the professional economists within the Departments and Bureaus, whose jobs can't be touched by the President, are still there, using the same models they always used, conducting the same policy-by-rote they do now.

An act of Congress could sweep away Civil Service Protections and allow the President to restaff the entire Government. I don't think this is going to happen near-term.

Obama could try to operate the government against its inclinations, the way Bush did on some aspects of foreign and tax policy, and it fought back, resulting in the wonderfully high reputation he has now. Or the way Governor Terminator tried in California for the first two years of his Governorship, which was so successful he was able to implement all the much-needed reforms and California is now on a sounder financial and economic footing today than Texas is.

Or not. I seem to recall he Finlandized in a vain effort to maintain popularity and keep in office, a strategy of being co-opted by Government Organized As A Special Interest, "go along to get along", that also worked out wonderfully for him (it's no wonder his popularity is in the 20s).

April 16, 2010 at 6:57 AM  
Blogger Porphyrogenitus said...

I hope things work out well for Gov. Christie in New Jersey, I really do. But the California example shows just how difficult it is, the trap any elected official is in, even one who was swept to power on as a result of a movement positively demanding serious reform, but then which was shattered by the hammer of the Official Press against the Anvil of the Civil Service apparatus (Impersonal Bureaucracy insulated from the governed).

Note I'm not saying "nothing can be done, and all is hopeless", just that a lot needs to be done and it won't all be in a year or two, just as this edifice wasn't built in a year or two or even a decade or two. It can probably be disassembled faster than it was assembled, but only by a movement that recognizes the full nature of the task, and that'll take some years to build up itself.

April 16, 2010 at 6:57 AM  
Anonymous zanon said...

jeff65: The problem is that the Govt is run by the Academy, and the Academy are Monetarists, or old-style MORON Keynesian (like Krugman) when things get tough. Even Austrians are better represented in the Academy that MMT!

No Government will do anything that will get laughed about in op-eds in NYTimes by Nobel Laureat Economists.

Look at thread on this blog. You make simple statement about how monetary system works and potty-mouthed idiots raise from dead and the zombie like repeat whatever they were awake from in economis 101.

April 16, 2010 at 9:23 AM  
Blogger Minitrue said...

Jeff:

"I'd like to know where you believe the smart money would run?"

Commodities, foreign currencies, tangible assets and the most stable equities. Those are the places money generally runs to amid inflationary fears.

"Treasuries are for the risk averse. Aside from USD there is no other market that could absorb the flow."

It is not only the people holding or wanting to buy treasuries who matter. It is everyone holding dollars who get affected by debasement. I'll try to spell out my thoughts in a simple example.

Imagine there are 100 dollars in private reserve accounts. Everyone who holds 1 dollar has 1% of the outstanding purchasing power. The government then spends 50 dollars by marking up reserve accounts. It also taxes 25 dollars by marking down reserve accounts. There are now 125 dollars in private reserve accounts. Everyone who holds 1 dollar now has .8% of the outstanding purchasing power.

But let's say the government borrows 25 dollars by selling treasury notes and bonds. It marks down reserve accounts by 25 dollars. There are now 100 dollars in reserve accounts. Each person holding one dollar in a reserve account has 1% of the outstanding purchasing power.

Now imagine the government had been doing this for many years. So it has some large amount of treasuries outstanding. If the government announced that it was paying off 100 dollars worth of treasuries without buying new ones or increasing taxes, what happens? There would then be 200 dollars in reserve accounts. Each dollar would represent only .5% of the outstanding purchasing power. Let's say you hold one dollar when the government announces it's plan to buy back the treasuries.

What are your incentives after notification that your purchasing power is going to be cut in half?

The government's finances do not happen behind closed doors. People will react to these straight forward incentives.


"Our major trading partners would never allow the USD to fall as much as would be required for the disaster you imagine because it would kill them too."

Yes, the disaster scenario will not happen for a lot of reasons. The major one being that, as stupid as USG is, it is smart enough to realize that monetizing a significant portion of its debt would be suicidal and catastrophic.

As for the "our democracy" point, I think Mencius has properly diagnosed some of the ways in which it doesn't work. I've seen enough democracy in action in my real job to know that the truth and what would make for good policy are more often than not irrelevant.

April 16, 2010 at 4:34 PM  
Blogger Porphyrogenitus said...

Btw yeah in my post where I referenced replacing those in office who have bad economic theories with new people holding the correct vision, I forgot we had dropped the Austrians and moved on to new gurus, who I hope are right but which to me seem even more bizzare.

But while I have a decent intuitive grasp of economics (and think Hayek was on to something), I'm hardly an expert and am wandering the posted links, holding my lantern, searching for an honest economics.

I do know that those in office tend to know as little of economics as they can get away with, and are interested in it primarly to the extent to which it gives them a rationale to do what they want to do anyhow. This largely explains the rise to prominence of certain theories, and the banishment of others to the outer darkness.

The theory that advances Wilsonian public policy will get funded, that which does not will not. I think Austrians should have expected that, but since I can't see where they did (am I wrong? I might be), and still fully hope and expect will some day be in favor once we all realize how right they were, there might be something wrong with their Praxis.

But then I don't think most theories take all variables into account. Which accounts for much of my admiration of Hayek.

April 16, 2010 at 6:35 PM  
Blogger Minitrue said...

"If you look at US reserve position today compared to past, you will see it is much much larger. I forget exact figures, but order of magnitude may be correct."

Yes, and the dollar has been steadily debased. We have much higher prices, but if the money supply had remained constant, prices would almost certainly have dropped because improved technology has resulted in more efficient production.

"Monetarists and Austrians both believe that, given US Gov balance sheet today, interest rates should be very high, but they are not. So, they fall back to "hyper inflation is juuust around corner now!"

I basically agree with this. I'm not predicting hyper inflation.

April 16, 2010 at 7:22 PM  
Blogger TGGP said...

Porphyrogenitus:
"dissassociates himself from anything ever said by the likes of Paul Krugman"
Krugman has said his share of sensible things, mostly before he was hired by the NYT.


zanon:
You've got it backwards. Government rules the academy.

My impression is that you (or more broadly, "MMT") is Post-Keynesian. Post-Keynesians in turn hew closer to the original writings of Keynes, disparaging the "bastard" neo-Keynesian which sought to meld it with neoclassical economics. Bryan Caplan ocassionally refers to the first wave of them as "dinosaur Keynesians", distinct from the New Keynesians (with so little connection to Keynes that righties like John Taylor or Greg Mankiw fit in) who emerged in reaction to the New (Neo)classical revolution spearheaded by Bob Lucas. So what do you mean by calling Krugman an old "MORONIC" Keynesian? It's been a while since I read the New Economic Perspectives from Kansas City blog (they seemed to shift over to New Deal 2.0), but I took them as representative Post-Keynesians, citing many of the same folks you do. And from what I recall, they were rather respectful towards Krugman in recent years (for some of the same reasons I prefer the old Krugman).

Also, the old monetarists were sidelined by Lucas' revolution as well. The paper on Chicago Marshallians vs Walrasians I linked about explains the difference. Of course, this is only relevant to academia, only saltwater/brackish economists are allowed to make policy.

"No Government will do anything that will get laughed about in op-eds in NYTimes by Nobel Laureat Economists."
There is basically a consensus among economists against a great money policies (international trade restrictions, agricultural subsidies) that we pursue anyway. Only one place has ever enacted congestion pricing (common sense among economists) democratically.


Minitrue:
I'm not predicting hyperinflation either. I'm satisfied with Sumner's EMH argument. Markets don't expect it, and they generally know a lot better than me. One amateur Austrian has been predicting deflation: "Mish" Shedlock.

April 16, 2010 at 11:03 PM  
Blogger Minitrue said...

TGGP:

Sorry, I should have been more precise. All I meant was that I agreed that hyperinflation isn't right around the corner, not that all Austrians believe it is.

April 17, 2010 at 5:53 AM  
Anonymous zanon said...

Minitrue: This is the problem with the "dilutionist" view of money you present (which is common Austrian view):

money in bank accounts are dead money.

If money is saved, it does not do anything. It has no impact on prices, and therefore, has no impact on inflation. banks do NOT lend out reserves.

Inflation is product of transactions (flow) not savings (stock).

Therefore, we see flat to declining prices (US is in mild deflation right now) but dramatically larger reserve position. Of course, if US was running smaller deficit, reserve position could be as large (as it is created by CB actions, not Treasury actions) and you would get even WORSE deflation and even lower real output. So, you have tradeoff between real output and preserving %s which have no impact on prices.

Currency, fundamentally, is not inflation hedge. Real assets are. If reserve quantities had psychological effect to move savings into real assets, you would see unemployment drop and recession end.

TGGP: Mencius would say academy controls Govt. Either way, the monetarist/old-Keynesian policies we see today (low interest rate/Gov spending on infrastructure) was cooked up in University, not in Congress.

PK is 45% accounting and 45% operational reality. The final 10% is politics, like all economics. As many PKs seem to be very left-wing, of course they like the Krugman, overlooking his factual errors because he is fighting for the right sides. Typical.

April 17, 2010 at 10:28 AM  
Blogger TGGP said...

Minitrue:
Yeah, I didn't really take you as dictating what all Austrians must believe, I just thought Mish provided an interesting contrast.


zanon:
I know Mencius argues that. I claim the evidence Wood & Mankiw present suggest that he is wrong. New ideas in government flow back to academia, not the other way around.

I think the government spending on infrastructure sometimes relies on Keynesian rhetoric, but is really motivated more by Galbraithian reasons. Of course, since Keynes himself advocated the permanent socialization of investment it's not actually much of a deviation from the original! The writers at NEPFKS have also noted the heavily Institutionalist flavor of the New Deal, despite its association in the popular mind with Keynesianism.


Back to the subject of MM's original post, the blogger at "Economics of Contempt" seems to know a lot about credit-default swaps.

April 17, 2010 at 1:06 PM  
Anonymous zanon said...

TGGP: I am actually sympathetic to Keynes' recommendations in 1930s. But that economy was very different from what we have today.

My criticism of old-Keynesiansim is that it never really formalized ideas so you got coherent, stock-flow coherent, accounting consistent, model of money economy. PK has done this.

I have no respect for Mankiw. he is no-nothing MORON.

April 17, 2010 at 3:06 PM  
Blogger Porphyrogenitus said...

TGGP quotes me without quoting me but that's fine as it's certainly the impression I left.

I used to read Krugman's books from time to time, back when he had something worth saying.

Interesting how the more prominent he is in saying stuff, the more worthless what he says is, as you yourself pointed out - which doesn't really refute the dynamic.

OtoH, I'm not that sympathetic to what Keynes had to say in the '30s, unless people want to say it was misapplied.

People always seem to believe economic laws (if they are laws) have changed somehow (when?) from point A to point B. I'm not sure when and why is ever explained.

What aspects of Keynes are right? In what ways was he right and those who didn't think he was were wrong?

Me, if I see someone suggesting that government should nationalize all investment, I know what that means, and while many people saw that model as viable in the '30s, they happen to have been wrong.

But if "all investment decisions should be made by government" sounds like a winner to you, well I do admit most of you know more about economics than I do, and apparently so did Brezhnev.

April 17, 2010 at 6:28 PM  
Blogger Porphyrogenitus said...

This comment has been removed by the author.

April 17, 2010 at 6:54 PM  
Blogger Porphyrogenitus said...

Btw, did people know that before Keynes we reliably built, IDK what to call it, *actual* infrastructure? Not predomenantly make-work projects sold on the basis of infrastructure, some of which may have been to some good end ubt really the cognocenti didn't care because the project was considered an end in and of itself, even if it was just the equivalent of digging ditches and filling them in again?

Thus "shovel ready" which for $800 billion will give us both diddly and squat of enduring value.

I could cry when I think what could have been done with the equivalent, or even much less, by those before.

We don't need Keynes for that (or Hayek for that matter). Much of what has been learned might be better being unlearned to better effect, but it is unlikely to happen - toothpaste can't be squeezed back into the tube.

It's one valuable thing about MM even if one doesn't swallow his entire argument. Frankly I'd rather be ruled by robber barons than what we have now. I think Rockefeller, Morgan, Carnegie, even Mellon or Ford for all their flaws - if you gave them 800 B$ and told them "spend it", we'd actually get something for the money and the economic effects would be massively positive.

Robber Barons = Force Multiplier
Keynesians = ? You tell me.
Compare and Contrast.

April 17, 2010 at 9:25 PM  
Anonymous zanon said...

Prophy: I am not historic specialist in Keynes, but in simple economy with low tax rate and commodity labor, Government spending is OK way to run deficit and fund increase private sector demand for savings. I do not have strong opinions on what was best to build in 30s, but infrastructure seems OK as well.

In 2010 we have complex economy, high tax rate, specialized labor. Infrastructure spending is terrible way to run deficit, but deficit is still needed to fund increase private sector demand for net savings and maintain real output (something that Austrians care about in abstract, yet have no regard for in actuality)

I have no idea who you are referring to when you say "all investment decisions should be made by Govt" as that certainly is not my view.

April 17, 2010 at 11:04 PM  
Blogger Porphyrogenitus said...

"...many references to 'earlier and simpler times' by people who have made no detailed study of those times, and who are unlikely even to suspect that it is their knowledge of the complexities of those times which is lacking, not the complexities themselves."
- Thomas Sowell, "Intellectuals and Society", p.29.

I don't think the economy of the '20s and '30s was as simple as people seem to think.

Indeed, I seem to remember from reading debates of the era that the claim was made then along the lines "oh, when the economy was simple, you might do X, but we have a complex industrial economy now, not a simple agricultural one."

One department where I *have* enough knowledge to make a reasonably confident statement is history, and I find the more I know of any given period the more complex and less simplistic it is.

Noting also that at least insofar as the American economy of the 1930s was Keynes didn't work:

http://www.friesian.com/images/unemploy.gif

(from http://www.friesian.com/sayslaw.htm there).

Some guy on TV and radio is/has compared what was done in this depression vs. that of 1920-21, clearly building on this: http://mises.org/daily/3788

I'm not sure what to make of that, except to note that we did have a depression then and it didn't last a whole decade, as the one in the '30s did.

For me it would be interesting to see Moldbug and/or some others look into that earlier depression from the primary sources (all of which are pre-1923, so it would be a Froudeian Project!

What was done different in that one vs. the one we all think we know about?

April 18, 2010 at 6:43 AM  
Blogger Porphyrogenitus said...

On the investment thing: I'm not sure how one can defend Keynes then disavow his policies. I asked which ones of his people think were good ideas, and highlighted the problematic aspects of what he advocated, including make-work "investments"/"infrastructure" in partial substitute for doing something that is really economically productive, and centralization of investment.


IMO, if the data is correct, the 1920/21 depression and how it was addressed showed that one doesn't need Keynesian government spending at all; they cut taxes but also cut spending (and by more than they cut taxes), reducing government debt rather than increasing it.

*IF* you're going to make an argument that was possible then but won't work now, please explain to me why, and beyond "times were simpler." - Treat me as dumb enough that this isn't an intuitively obvious universal salvant to me.

April 18, 2010 at 6:50 AM  
Anonymous zanon said...

Porphy: I believe that in 1930s, taxes were much lower, so for Govt to run larger deficit to fund increase in private demand for savings, higher spending was the easier lever. Maybe taxes were high enough then that that lever was still available, I do not know, but I suspect that I am right.

So, Keynes got right answer (deficit spend) but was not explicit about reason (fund increase in private sector to net save). In today's economy, with our much higher tax rate, tax holiday becomes no brainer policy.

You must understand balance sheet dynamics of economic sectors. Private sector can increase or decrease size of its balance sheet by taking on (or reducing) debt, but can never increase net financial assets by accounting (mechanism described by me earlier). So, financial assets and liabilities can get bigger, but never equity. Equity can just be shuffled intra-sector.

Suppose private sector wants to increase net financial asset. it cannot. all it does is reduce its own income as velocity falls. if it has nominal debt, it defaults, as lower prices make debt burden worse. minsky and fisher wrote about this. result is high unemployment and lost real output (which austrians profess to care so much about, but really do not)

In this situation, you either take the unemployment hit, let prices fall to what unlevered buyer would pay, lose real output, and start again (or have coup). Or you have Govt create positive net financial assets for private sector by running deficit.

This type of thing was typical in gold standard system as debt deflation is just how such system works. Not great.

If govt runs surplus, it drains private sector of savings. OK. Either employment can fall now, or sector can replace savings with more debt and maintain spending. In 1920s, Govt surpluses lead to big run up in private debt which all collapsed and lead to depression. In 1990s, Clinton surpluses likewise lead to big run up in private debt and here we are in 2010.

It is also possible for private sector to export its way to higher savings to make up for Government drain via surplus. This means it gives up real consumption though as terms of trade are against it. Also a bad outcome.

Australia is interesting now as it is large economy that really has pushed through Great Recession by piling on even more private debt. We shall see how it turns out. And Eurozone is trying to export its way out of its problems as it does have gold standard -- we shall also see how it does

April 18, 2010 at 8:46 PM  
Blogger Porphyrogenitus said...

Re. my comments on Hayek: Note it's not that I think he had the key to all economic wisdom either (or I wouldn't be carrying my lantern); I was reflecting mainly on his emphasis on limited knowledge of policy makers.

Zanon: I think you're incorrect on tax rates in the '30s. For tax rates in the mid '20s, you're probably right.


Top rates don't tell one everything about the overall burden, but Hoover dramatcally increased them during the early '30s. In 1932 - Income, top rate: 63 percent

1936 - Income tax, top rate: 79 percent. Roosevelt also institutes an inheritance tax, estate tax, gift taxes, dividend tax and progressive corporate tax.

(of course Hauser's Law implies that the tax revenues as a % of GDP may not have been much different than we get now. But the higher rates, along with whatever loopholes, would almost certainly have distorted economic activity. One doesn't have to be a fanatic Supply-Sider to accept that).

The deficit spending of the '30s didn't increase growth; perhaps private savings you say it would encourage was more discouraged by the confiscatory rates of taxation and other penalties FDR enacted on private-sector investing and economic activity.

Given you didn't know what rates were, you might be operating under other gaps in information about at least the U.S. economy in the 30s, and believe the policies enacted then led to recovery, when in fact they almost certainly prolonged the depression http://newsroom.ucla.edu/portal/ucla/FDR-s-Policies-Prolonged-Depression-5409.aspx?RelNum=5409

as I highly suspect current U.S. policies are doing. Which doesn't mean there won't be a recovery, nor even does it mean we won't see decent growth this year, but I *suspect* it will be despite rather than because of, or at least not as good as it could be under better policies. Obviously this is an unprovable claim on my part but given that you think a tax holiday would be better, we prolly at least agree on that much.

April 18, 2010 at 9:16 PM  
Blogger TGGP said...

"In 1990s, Clinton surpluses likewise lead to big run up in private debt and here we are in 2010."
Under Bush we had deficits, so shouldn't that have prevented a recession? If we accept that over time there are always going to be ups and downs then after any period of surplus you'll be able to point to a later recession and say, "Look, see there! I told you it would happen!".

April 18, 2010 at 10:04 PM  
Blogger jimbo said...

"Under Bush we had deficits, so shouldn't that have prevented a recession?"

Well, the Bush deficits did lead the to the recovery of the mid-2000s, but they were never really big enough to make up for the Clinton surpluses.

Also, there deficits and then there's deficits. The Bush tax cuts were designed to benefit the rich. Since the rich tend to save more of their income than those furthur down the income scale, they translated into a large numerical increase in savings, but skewed toward the upper classes. The overall balance sheet of the private sector improved, but the intra-private sector balance continued to get out of whack (as the lower classes used increased access to credit to maintain living standards, thus getting more and more in hock to the rich. The problem with this, of course, is that it's a self limiting process: when the debt grows to the point where the debtors can't make the payments anymore, it comes crashing down.

One of the reasons a payroll tax holiday would be a good thing is that most of it's benefits go to the lower incomes. Not just from a bleeding heart social justice point of view, but because it attacks balance sheets from the bottom up.

I would also note that the graph of depression unemployment posted upthread omits an important event: in 1937 the SS tax started to be collect from worker's paychecks, although the first benefits would only be paid years later. This significantly increased taxes and reduced the deficit.

April 19, 2010 at 10:02 AM  
Blogger Porphyrogenitus said...

"Also, there deficits and then there's deficits. The Bush tax cuts were designed to benefit the rich."

Actually, when it comes to proportion of income tax burden borne by income quintile, it shifted the burden *upwards*; it was *designed* so that the rich paid a proportionately greater share of the total income tax after the cuts than before, which they did. Here's a bar graph with actual data, since we like bar graphs: http://www.americanthinker.com/3%204%2010%20pic%201.jpg

I'm finding the people who supposedly know more than me seem to actually know less. >_<

Since we have a lot of experts on economics here, have any of you read Arnold Kling & Nick Shultz's book "From Poverty to Prosperity"?

If so, what do you think of their "Economics 2.0"?

Note I haven't read it yet myself, I've only seen a C-SPAM discussion of it featuring them and some others.

April 19, 2010 at 10:59 AM  
Blogger Porphyrogenitus said...

"they translated into a large numerical increase in savings"

I did a double-take on this one, too. Um, what data do you use for that, since we like data?

The only data I can find on savings rates are charts that look something like this:

http://www.stlouisfed.org/publications/re/2006/c/images/saving_rate_chart.gif

Here's another (of dozens):

http://www.drduru.com/money/charts/071223_SavingsRate.jpg

So if you are among those who think savings are bad, especially when done by filthy richers, who presumably put it in their sock drawer with their gold cufflinks instead of, oh, IDK, making it available for *actual* investments (as opposed to our new understanding of investment as gummint giving Obamamoney to those who don't have it so they'll buy rims and neon undercarriage lighting for their cadallac, thus creating a demand for same and leading to investment into same), then there was less of a problem under the ebil Bush Regime than before: Savings continued its long-term downward trend, a trend that's gone on for a quarter of a century now.

April 19, 2010 at 11:11 AM  
Blogger Porphyrogenitus said...

Social Security tax rate in 1937 was 1%/1% rather than the current 6.2%/6.2% - arguably the 2% increase in tax burden along with the other things FDR did at the time created the depression within a depression, but I'm not sure it was the sole factor for prolonging the depression, as you seem to imply.

It should make one wonder what might happen when the Bush tax cuts expire, but if you believe that only the ones on the rich will and given the economic model folks here seem to embrace's view on that, well presumably we needn't worry about it.

April 19, 2010 at 11:26 AM  
Anonymous zanon said...

Porphy: Marginal tax rates are important in micro sense, but at macroeconomic level what matters is total quantity of tax (as you say, "overall burden") -- that is what shows up in balance sheets. I do not know what % of GDP was taxed at Federal level in 1930s, but I am pretty sure it is small than burden in 2010, regardless of what tax rates are between two periods. Remember, US is currency issuer at Federal level, not state level. If Fed Govt just suspended all Fed taxes in 1930, I suspect it would not reduce fiscal drag much as it was not creating fiscal drag much in first place. 2010 is different story.

TGGP: Bush deficits did help, but not enough. But look, I am demonstrating my point through accounting and operations. Others brought up real world example (which is fine but please all realize that economics and history are not science).

Larger deficits add to inflation bias, but may or may not cause inflation. The question is always how does size of deficit compare to change in private sector demand to net save? It is meaningless to compare to % GDP etc -- who cares in fiat regime?! Unemployment and inflation tell you if you are over or under on target.

Arnold Kling is a total MORON who combines the intellectual rigidity of failed academic with the status of amateur blogger. worst of all worlds.

You need to be careful when looking at savings data. Remember, we are talking about non-Govt sector, so you must include household, business, and balance of payments to handle dollars saved by rest of the world (whom could be Governments, but are not US Gov and therefore are currency users like rest of us). Add it all up correctly, and you will see that per period it matches deficit, and sum equals debt.

"National Savings" is meaningless number in fiat currency regime and is holdover from gold standard days, as is most of this nonsense.

The connection between investment and savings is actually the most counter-intuitive of all of this in my mind. If you do not understand how bank loans create deposits (which I think you do), and how Govt must deficit spend to give non-Govt sector money to pay tax and net spend (which I do not think you do yet, maybe I am wrong), then you are not ready for how investment creates savings. And yes, I have causality correct there.

jimbo: I have ignored composition and distribution issues, focusing on original statement that Fed deficit spending is only thing that can fund private demand for net financial savings. Many factors can impact private sector demand to net save, including composition and distribution of individual households.

April 19, 2010 at 11:38 AM  

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