The Management of Fiat Money

I want to review the 4th comment on AlwaysLand, Greg's comment. I begin by putting the comment in my own words, to make clear what I understand Greg to say.

One thing I'm not sure your accounting for is the currency issuer. They still have the power to "fund" the savings desires of the private sector and keep aggregate demand high enough for employment not to fall.

In other words, the currency issuer -- the federal government -- can create enough money to satisfy both "the savings desires of the private sector" and enough "aggregate demand" to keep unemployment reasonably low.

In that video I asked you to watch with Stephanie Kelton, there was a second video with a Q&A session. Very poor audio for parts of it but one place you can hear Mosler very clearly and he is talking about inflation (not hyperinflation) and he says something interesting. That inflation is never a REAL problem. It is simply a situation that humans get uncomfortable with and we must remember that but there is never real economic hardship DUE TO inflation. People are getting richer and paying higher prices but they can meet all their financial obligations out of their incomes usually. I dont care if bread is 6$ loaf if I only have to work 5 minutes to earn that 6$. The real question is how much work am I having to do to pay my cost of living, and in most inflationary situations through history, that is not usually a problem according to Mosler.

Mosler says inflation doesn't create hardship, so it isn't really a problem.

I think we get waaaay to inflation scared and therefore always run deflation bias which kills us in times of large debt.

And Greg says that deflation (by contrast) really is a problem.


Next, I summarize my restatement of Greg's comment, and then respond.

Inflation doesn't create hardship, so it isn't really a problem. But deflation really is a problem. And since the federal government can create enough money to satisfy both our desire to save and our need to grow, that is what it should do.

In other words:
1. The government can print as much money as it wants; and
2. Inflation is an acceptable solution.

Wow. Inflation is not an acceptable solution.


Look: Fiat money has an advantage over gold-backed money, in that fiat gives us more flexibility. For example, my idea to "print money and use it to pay off private-sector debt" could not possibly be done if we were on a gold standard. Today, however, we have the flexibility that makes it possible.

Having a fiat monetary system gives us an advantage. So, our present monetary system better prepares us to deal with monetary problems than the old system. What that means is we should better be able to achieve the same goals.

It does not mean we should claim that inflation is okay. It means we should have better chances of avoiding inflation and other monetary problems, than anyone in history.

In a recent comment here, JB Peebles links to No Exit, a post by James G. Rickards. The post is most interesting and seems a good assessment of the problem faced by the Federal Reserve. I recommend you to read it, for Rickards' logic is exquisite.

Exquisite and painful. Rickards' conclusion is that there is no way out of the problem. As he puts it, "there is no exit."


If you want to solve this problem, you have to think "outside the box" -- something neither Rickards nor the Fed is doing. The solution is not difficult to implement. Nor is it difficult to understand. It is only outside the range of our normal thinking.

All the while the economy was growing, assets were increasing in quantity and value. But since the Paulson Crisis, assets are decreasing in value and it seems we have too many of them. This is a supply-and-demand thing: When the value of those assets came into question, demand for them fell.

If we had fewer of those assets, the demand for them would be relatively greater. If we had fewer assets, the assets would fall less in value, or the value would stabilize or perhaps even begin to increase again. Supply and demand, plain and simple. And if we could get rid of the "bad" assets, so much the better.

As Rickards notes, "...some of the junkier assets and mortgages will not pay off, ever." Those are the ones we want to get rid of. Actually, those are the ones we are getting rid of, and which the Federal Reserve is accumulating. And this (as Rickards points out) is becoming a problem for the Fed.

These "junky mortgages" are not the only problem. The Fed is accumulating that crap by paying for it with newly printed money. And (again, as Rickards points out) "Critics also raise the issue that this much money printing will result in inflation."

Get Out of the Box, Dammit

Borrowing increases, and loan repayment decreases the quantity of money.

The Fed has to stop doing things by reflex. The Fed has to stop injecting money into the economy, where it will lead to inflation. But the Fed has to solve the problem, and the only tool it has is the ability to print money.

The Fed has been printing money and using it to buy up bad assets to get them out of the economy. What the Fed must do instead is simple: use that money to pay off those "junky mortgages." That makes the bad assets good, and that solves a huge problem.

It also makes the debt go away. By paying off junky mortgages, we reduce the level of outstanding debt. That reduces risk in the economy. And that solves a huge problem.

And paying off those debts makes the newly printed money go away. Loan repayment decreases the quantity of money. By paying off junky mortgages, the Fed destroys the newly printed money and reduces the risk of inflation. And that solves a huge problem.

We can fix this thing before it is too late.

Give and Take

The U.S. dollar is backed by U.S. government debt. That isn't MMT. It is how things have been since the time of Lincoln.

The double-entry thing: The dollar is the "asset" that mirrors the "liability" of government debt. I think this is MMT, but I could have figured it out for myself.

What I take from MMT: A dollar of money cannot exist unless there is a dollar of federal debt to mirror it. (This statement is equivalent to the one above.)

What MMT must take from me: If the government prints exactly as much money as MMT says it should, and if it spends only in the best ways as approved by MMT, but if it fails to reduce the relative level of private-sector debt, the plan will fail.

Observations

It's funny... When I started writing AlwaysLand (October 18th) I was perfectly happy with the standard assumptions I was relying on. But by the time I was getting ready to post it a week or so later, there were second thoughts. I looked at my assumption that says we need to have saved so there is money to borrow --

If we have a monstrous debt, then we must have done a lot of borrowing. So there must have been a lot of saving, which was loaned out to generate that debt.

-- and I thought, Well, the MMT people are gonna object to that! By then I had some of this in my head, from Scott Fullwiler:

But, the act of purchasing MBS and creating a deposit doesn't help a bank create money. Banks can already create as much as they want even without the Fed doing this.

Fullwiler seems to say there could be plenty of debt without any saving at all. So I was relieved when (in the first comment to AlwaysLand) Greg took my "a lot of saving" and matched it up to the national debt. Greg said something interesting, when I was expecting an argument. It worked out well.

During that intervening week, I obviously changed my thinking about MMT. No, I'm not buyin' that load'a crap... but I am starting to think it's not all crap. I'm getting past their bizarre claims, and I can finally notice some of their interesting observations.

What happened? I'm not sure. The Stephanie Kelton video [Session 2 video - part 1] came later, but captures a thought. About 90 seconds into her talk, Kelton says:

It's not a theory... What we have been describing to you today is not dependent on any ceteris paribus condition or any set of assumptions about perfect competition or rational agents or anything else that you get exposed to when you study economics, but rather an attempt to simply describe the way in which the institutional arrangements are set up, and the accounting identities and what happens...

I can see that: They're just describing "operational" realities. I think they're leaving out some practical realities. And I think they need a theory, a little Arthurian theory. And they reach conclusions I'll never get to. But observations are observations, and these guys are showing me a few things I've not seen before. I like that.

So, how did I get here? Winterspeak, I think. I followed Tschäff's link to Winterspeak and found something that made sense:

When the Government spends, and then taxes, it injects money into the private sector, and then withdraws it.

Nothin' to it, really. Government spending works just like the Fed's monetary control in a way, and just like anybody else: Either I'm spendin' my money or I'm sittin' on it. That makes so much more sense to me than this:

So the absolute fact of the matter is, the government never has nor doesn’t have dollars. It taxes by changing numbers down, but doesn’t get anything. It spends by changing numbers up and doesn’t use up anything.

Winterspeak put it in a way that made sense to me, and that has made all the difference.

Krugman says...

The background to the world economic crisis is that we went through an extended period of rising debt...

Oh, and widespread debt forgiveness ... would solve the problem.

ACCOUNTING IDENTITIES, 30 OCT 2010


My plan is simple.

I want the Fed to print money and use it to pay off debt.
And I want'em to do it until the economy is growing again.

The Far Side of the Moon

I have a question.

This isn't it: The U.S. Dollar is backed by federal debt.

When you walk around that fact, inspect it, kick the tires and such, you get to the far side of it, where you can see what it means that the dollar is backed by debt. What it means is, for every dollar of money -- every dollar of base money, I think -- there must be a dollar of federal debt to back it up. There has to be that debt.

Okay?

So now, the question: Does there also have to be a dollar of money, for every dollar of federal debt? No... But I'm thinkin there has to be a dollar of money for every dollar of federal debt held by the Federal Reserve. Is that right?

Any thoughts? The fate of an upcoming post depends on your answer.

Geometric Constants

An old London Banker post links to Irving Fisher's Debt-Deflation Theory of Great Depressions (PDF) which reads in part:

Disturbances in these two factors -- debt and the purchasing power of the monetary unit -- will set up serious disturbances in all, or nearly all, other economic variables. On the other hand, if debt and deflation are absent, other disturbances are powerless to bring on crises comparable in severity to those of 1837, 1873, or 1929-33.

I quote this for the dates. Fisher identifies three severe disturbances, to which we can add a fourth: Call it 2008.

I just want to do a little work with numbers here. I'm not gonna claim anything weird, other than what I'm showing you is weird.

It's 36 years from 1837 to 1873.

It's 56 years from 1873 to 1929.

56 years is 1.555 times as long as 36 years.

I want to test this number 1.555 as a geometric constant.

Suppose the next disturbance after 1929-33 comes after a period of years that is 1.555 times longer than 56 years.

That's about 87 years.

Starting in 1929 and going 87 years puts the next disturbance at 2016.

Our disturbance started in 2008. Eight years early. Pretty close, right?

Told ya it was weird.


Now we just have to hope there isn't a similar geometric constant that applies to the severity of these disturbances. But I would bet there is one.

Election Day Reminder

Howard Beale (Peter Finch)
delivering his "mad as hell" speech

Everybody's "mad as hell" these days.

I just hope everybody remembers it was the 1976 movie Network that made those three words famous.

And I hope everybody remembers that in the movie, things didn't work out so great for the angry man.

In Case You Missed It

And the problem, in case you missed it, is that we use dogmatic, open-ended rules of thumb in our economic thinking, rules of thumb like printing money causes inflation and this one: Credit use is good for growth.

Open-ended rules are rules we apply without letup. The inflation rule tells us that if there is inflation, they must be printing too much money. But the rule doesn't ever have us check to see if there is even any money left.

And the credit rule tells us that if we want the economy to grow, we need to use more credit. This rule doesn't ever have us stop to see if we've used too much credit already, if we've accumulated too much debt, if we've passed a Laffer Limit, if we've crossed the line. The rule just tells us to use more credit.

In the Arthurian view, these two rules of thumb together created the problems in our economy. We always restrict the quantity of money, and we always use more credit. (Thus the name AlwaysLand.)

After you do those things for a good long time, the economy doesn't work any more.