Nearly all of human life has always passed far from hot baths

January 7, 2014 § Leave a comment


We are now in a position to demonstrate our proposition: the natural rate of interest is zero. First, to reiterate the argument thus far: Under a state money system with flexible exchange rates, the monetary system is tax driven. The federal government, as issuer of the currency, is not revenue constrained. Taxes do not finance spending, but taxation serves to create a notional demand for state money. Spending logically precedes tax collection, and total spending will normally exceed tax revenues. The government budget, from inception, will therefore normally be in deficit, which also allows the nongovernment sector to “net save” state money (this in fact has been observed in all state currencies).

The Natural Rate of Interest Is Zero
If spending is not revenue constrained, why does the government (conceived here as a consolidated Treasury and Central Bank) borrow (sell securities)? As spending logically precedes tax collection, the government must likewise spend sufficiently before it can borrow. Thus, government spending must also, as a point of logic, precede security sales. To cite a “real world” example, market participants recognize that when Treasury securities are paid for, increasing Treasury balances at the Fed, the Fed does “repos” on the same day; the Fed must “add” so the Treasury can get paid.

Since the currency issuer does not need to borrow its own money to spend, security sales, like taxes, must have some other purpose. That purpose in a typical state money system is to manage aggregate bank reserves and control short-term interest rates (over night interbank lending rate, or Fed funds rate in the United States).

In the contemporary economy, government “money” includes currency and central bank accounts known as member bank reserves. Government spending and lending adds reserves to the banking system. Government taxing and security sales drain (subtract) reserves from the banking system. When the government realizes a budget deficit, there is a net reserve add to the banking system. That is, government deficit spending results in net credits to member bank reserve accounts. If these net credits lead to excess reserve positions, overnight interest rates will be bid down by the member banks with excess reserves to the interest rate paid on reserves by the central bank (zero percent in the case of the USA and Japan, for example). If the central bank has a positive target for the overnight lending rate, either the central bank must pay interest on reserves or otherwise provide an interest-bearing alternative to non-interest-bearing reserve accounts. This is typically done by offering securities for sale in the open market to drain the excess reserves. Central Bank officials and traders recognize this as “offsetting operating factors,” since the sales are intended to offset the impact of the likes of fiscal policy, float, and so forth on reserves that would cause the Fed funds rate to move away from the Fed’s target rate.

Our main point is, in nations that include the USA, Japan, and others where interest is not paid on central bank reserves, the “penalty” for deficit spending and not issuing securities is not (apart from various self-imposed constraints) “bounced” government checks but a zero percent interbank rate, as in Japan today.

The overnight lending rate is the most important benchmark interest rate for many other important rates, including banks’ prime rates, mortgage rates, and consumer loan rates, and therefore the Fed funds rate serves as the “base rate” of interest in the economy. In a state money system with flexible exchange rates running a budget deficit—in other words, under the “normal” conditions or operations of the specified institutional context—without government intervention either to pay interest on reserves or to offer securities to drain excess reserves to actively support a nonzero, positive interest rate, thenatural or normal rate of interest of such a system is zero.

This analysis is supported by both recent research and experience.  read more

PHOTOGRAPH: Pixy Yijun Liao

The cessation was glibly attributed to the Great Fire: but in every other city in England the Plague ceased at about the same time

November 21, 2013 § Leave a comment


While virtually all mainstream economists believe in a long-term Say’s Law (supply creates demand, so the ultimate constraint on long term growth comes from the supply side), the real constraint on long-term growth in a developed capitalist economy is always on the demand side. (Note that there’s nothing new in the Summers/Krugman recognition of secular stagnation; David Levy called it a “contained depression” in 1991; Wallace Peterson announced a “silent depression” in 1994; and I demonstrated in 1999 that the problem is chronically constrained demand. At a recent Levy Institute conference in Rio, Paul McCulley laid out what he called a fundamental economic principle: Microeconomics and Macroeconomics are inherently different disciplines. Macro is demand-side; micro is supply-side. For any practical time horizon, demand always drives supply.)

I know what I’m saying is heretical, even though it is fully backed by all the data. And this stagnation is not due to a liquidity trap, or to a negative “natural” rate of interest. It is in the nature of the productivity of capitalist investment in plant and equipment. To put it in simple terms, the problem is that investment is just too damned productive.  read more

PHOTOGRAPH: Antonio Olmos

Sand integument. Grains blown into navel. Stone-studded between toes

June 10, 2013 § Leave a comment


This design maintains the mutual elements of the UK banking system – our common cash machine system and payments infrastructure as well as the ‘free banking’ transaction system, it frees the lenders from a crippling cost obligation and it ensures that everybody can rely on ‘cash in the bank’ being there – regardless of the turmoil in the lending institutions.

The one casualty is interest on deposits. To have interest on deposits in a private system there has to be income from somewhere else to pay that interest. Therefore in this system it becomes a line item of government spending – likely via interest bearing accounts for individuals at National Savings. Paying interest on deposits in this way is then really just the same as paying coupons on Gilts. Gilts, of course, would cease to be issued under any rational government.  read more

PHOTOGRAPH: [unattributed]

‘She reads at such a pace,’ she complained, ‘and when I asked her where she had learnt to read so quickly, she replied “On the screens at Cinemas.”’

May 15, 2013 § Leave a comment


This morning I saw a very nice quiz concocted by a financial markets guy. I don’t want to get him in trouble so will borrow heavily from him but without attribution. If you can get this right, then you know why Quantitative Easing One, Two, and Three is a big bunch of baloney.

Consider the following thought experiment. These are the scenarios; what is the expected result of each?

A. The Treasury decides that it will fund itself 30% more in Overnight Bills and reduce bond issuance across the curve.

B. The Fed announces it will increase QE by 30% (it will remit the net income of this activity back to the Treasury).

C. Congress announces a new tax on all passive income from USTreasuries, to holders both at home and abroad (ie Central Banks), for all new-issue USTreasuries. The tax will be equal to 30% of the return in excess of the fed funds rate.

D. Treas Secty Lew pre-announces that we will ‘selectively default’ and apply a haircut of 30% on all future Treasury coupon payments of new issues in excess of fed funds rate.

What will be the likely effects of each policy? Don’t peek!

OK here is what the markets guy (rightly) says:

Here’s what’s funny. Most intelligent market participants will say things like:

A. Stocks down a few percent on fear of US debt downgrade. Economy slightly weaker or unchanged.

B. Stocks up 5-10% and economy grows another 1% for 1-2 yrs; monetary stimulus.

C. Stocks down 5-10% on tax hike (like last year) that maybe corrects. Economy slows 1-2% for a year or so because it’s a tax hike (ie fiscal consolidation).

D. Stocks down 80% and we go into a great depression on steroids. All investment dollars flee the US. I can’t tell you what happens next because my Bloomberg account gets shut down. They might even declare an Internet Holiday.

Here’s what’s craziest: THESE ARE ALL THE SAME THING. The name and the processes are different, the OPTICS are different, but the net is the same. There’s the government and there’s everyone else. The government either pays more out – in interest payments or transfer payments or vendor payments, or it takes back more in taxes or default or interest ‘savings.’ Everything the government net gets in ‘revenue’ the rest of the world loses in income. Everything the government dissaves (deficits) the rest of the world saves. Equal and opposite.  read more

COPY: Matt Bloom

Writing a novel about a man who leaves his wife and three children and goes to live alone on the other side of London to write a novel about a man who leaves his wife and three children

November 14, 2012 § Leave a comment

When the Fed buys assets, it purchases them by crediting banks with reserves. So the result of QE is that the Fed’s balance sheet grows rapidly—to, literally, trillions of dollars. At the same time, banks exchange the assets they are selling (the Treasuries and MBSs that the Fed is buying) for credits to their reserves held at the Fed. Normally, banks try to minimize reserve holdings—to what they need to cover payments clearing (banks clear accounts with one another using reserves) as well as Fed-imposed required reserve ratios. With QE, the banks have ended up with humongous quantities of excess reserves.

As we said, normally banks would not hold excess reserves voluntarily—reserves used to earn zero, so banks would try to lend them out in the fed funds market (to other banks). But in the ZIRP environment, they can’t get any return on lending reserves. Further, the Fed switched policy in the aftermath of the crisis so that it now pays a small, positive return on reserves. So the banks are holding the excess reserves and the Fed credits them with a bit of interest. They aren’t thrilled with that but there’s nothing they can do: the Fed offers them a price they cannot refuse on the Treasuries and MBSs it wants to buy, and they get stuck with the reserves.

A lot of people—including policy makers—exhort the banks to “lend out the reserves” on the notion that this would “get the economy going”. There are two problems with that. First, banks can lend reserves only to other banks—and all the other banks have exactly the same problem: too many reserves. A bank cannot lend reserves to your household or firm. You do not have an account at the Fed, so there is no operational maneuver that would allow you to borrow the reserves (when a bank lends reserves to another bank, the Fed debits the lending bank’s reserves and credits the borrowing bank’s reserves). Unless you are a bank, you cannot borrow them.

The second problem is that banks don’t need reserves in order to lend. What they need is good, willing, and credit-worthy borrowers. That is what is sadly lacking. Those who are credit-worthy are not willing; those who are willing are mostly not credit-worthy.

And we should be glad that banks are not currently lending to the uncredit-worthy. Here’s why: that’s what got us into this mess in the first place.  read more


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