John Rubino: Has The Debt Jubilee Already Started?

[NCR85]

http://www.financialsense.com/contri...lready-started

This is very much in line with my recent thinking on the subject. If QE is extended into perpetuity, any bonds thus bought being rolled over forever on the central bank’s balance sheet, the effect is equivalent to a public debt jubilee, since any interest paid on the bonds will be returned to the treasury, as if the debt paper isn’t there. The public sector then can propagate it’s renewed financial robustness into the private sector either by engaging in stimulus spending or by lowering taxes now or communicating to do so in the future. Of course it can also do a formal debt-jubilee based on public sector funding.
What I’m wondering about is whether this will in the end create net inflation. I understand that debts to a certain extent confer a disinflationary pressure on consumer prices and this counteracts that. But haven’t central banks in the past lowered interest rates to counteract the debt-deflation and won’t they need to raise them again to make the situation inflation neutral? Can they do that, or is their balance sheet too much impaired? Raising interest rates requires the sale of assets, right? Do they have enough of them?

[NCR85]

Re: John Rubino: Has The Debt Jubilee Already Started?

Wow, it just dawned on me that I've come around to viewing things exactly how EJ explained it when I asked "how can the government get out of debt by borrowing" a few months ago. It's really, really easy when they have the central bank on their side.

[thriftyandboringinohio]

Re: John Rubino: Has The Debt Jubilee Already Started?

Wow, it just dawned on me that I've come around to viewing things exactly how EJ explained it when I asked "how can the government get out of debt by borrowing" a few months ago. It's really, really easy when they have the central bank on their side.

“The process by which banks create money is so simple that the mind is repelled.”
- John Kenneth Galbraith

[globaleconomicollaps]

Re: John Rubino: Has The Debt Jubilee Already Started?

http://www.interfluidity.com/v2/3694.html
There’s no such thing as base money anymore

Tim Duy has a great review of why platinum coin seigniorage was a bridge too far for Treasury and the Fed. I think he’s pretty much spot on.

However, with Greg Ip (whose objection Duy cites), I’d take issue with the following:

Ultimately, I don’t believe deficit spending should be directly monetized as I believe that Paul Krugman is correct — at some point in the future, the US economy will hopefully exit the zero bound, and at that point cash and government debt will not longer be perfect substitutes.

Note that there are two distinct claims here, both of which are questionable. Consistent with the “Great Moderation” trend, the so-called “natural rate” of interest may be negative for the indefinite future, unless we do something to alter the underlying causes of that condition. We may be at the zero bound, perhaps with interludes of positiveness during “booms”, for a long time to come.

But maybe not. Maybe we’ll see the light and enact a basic income scheme or negative income tax brackets. Maybe we’ll restore the dark, and engineer new ways of providing fraudulently loose credit. Either sort of change could bring “full employment” interest rates back above zero. Let’s suppose that will happen someday.

What I am fairly sure won’t happen, even if interest rates are positive, is that “cash and government debt will no[] longer be perfect substitutes.” Cash and (short-term) government debt will continue to be near-perfect substitutes because, I expect, the Fed will continue to pay interest on reserves very close to the Federal Funds rate. (I’d be willing to make a Bryan-Caplan-style bet on that.) This represents a huge change from past practice — prior to 2008, the rate of interest paid on reserves was precisely zero, and the spread between the Federal Funds rate and zero was usually several hundred basis points. I believe that the Fed has moved permanently to a “floor” system (ht Aaron Krowne), under which there will always be substantial excess reserves in the banking system, on which interest will always be paid (while the Federal Funds target rate is positive).

If Ip and I are right, Paul Krugman is wrong to say

It’s true that printing money isn’t at all inflationary under current conditions — that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end.

Printing money will always be exactly as inflationary as issuing short-term debt, because short-term government debt and reserves at the Fed will always be near-perfect substitutes. In the relevant sense, we will always be at the zero lower bound. Yes, there will remain an opportunity cost to holding literally printed money — bank notes, platinum coins, whatever — but holders of currency have the right to convert into Fed reserves at will (albeit with the unnecessary intermediation of the quasiprivate banking system), and will only bear that cost when the transactional convenience of dirty paper offsets it. In this brave new world, there is no Fed-created “hot potato”, no commodity the quantity of which is determined by the Fed that private holders seek to shed in order to escape an opportunity cost. It is incoherent to speak, as the market monetarists often do, of “demand for base money” as distinct from “demand for short-term government debt”. What used to be “monetary policy” is necessarily a joint venture of the central bank and the treasury. Both agencies, now and for the indefinite future, emit interchangeable obligations that are in every relevant sense money. [1]

I’ve no grand ideological point to make here. But I think a lot of debate and commentary on monetary issues hasn’t caught up with the fact that we have permanently entered a brave new world in which there is no opportunity cost to holding money rather than safe short-term debt, whether we are at the zero bound or not.

[1] Yes, there are small frictions associated with converting T-bills to reserves or cash for use as a medium of exchange. I think they are too small to matter. But suppose I’m wrong. Then nonusability as means of payment would mean a greater opportunity cost for T-bill holders than for reserve holders. That is, printing money outright would be less inflationary than issuing short-term debt! And for now, when Fed reserves pay higher interest rates than short-term Treasury bills, people concerned about inflation should doubly prefer “money printing” to short-term debt issuance! Quantiative easing is currently disinflationary in terms of any mechanical effect via the velocity of near-money, when the Fed purchases short-term debt (although it may be inflationary via some expectations channel, because of the intent that’s communicated). The mechanical effect of QE is less clear when the Fed purchases longer maturity debt, it would depend on how market participants trade-off the yield premium and interest rate risk, as well as on what long-term debt clienteles — pension funds etc. — choose to substitute for the scarcer assets. But it is not at all obvious that “printing money” to purchase even long maturity assets is inflationary when the Fed pays a competitive interest rate on reserves.

Thanks to Kid Dynamite for helping me think through some of these issues in correspondence (though he doesn’t necessarily agree with me on any of it!)


http://economistsview.typepad.com/ti...inum-coin.html

On The Disruptiveness of the Platinum Coin

Apparently fiscal and monetary cooperation is alive and well - the US Treasury and the Federal Reserve conspired to kill the platnium coin idea. In retrospect, we should have seen this coming. As the debate continued, it became increasingly evident that the platinum coin threatened the conventional wisdom in very deep and profound ways. It was a threat that could not be endured by Washington.

This realization hit me this morning, working on my last piece. Begin with the effectiveness of monetary policy at the zero bound. Or, more accurately, the lack of effectiveness as the Federal Reserve is swapping one zero-interest asset for another. Rarely do we take this to its logical conclusion for fiscal policy: If there is no difference between cash and Treasury bonds, why should we issue bonds at all? Why not simply issue cash? In other words, at the zero bound, what is the argument against monetizing deficit spending?

Indeed, the lack of any difference explains how Japan can sustain massive fiscal deficits year after year. At the zero bound, cash and government debt are the same thing. We would assume that as long as inflation was not a concern (which it wouldn't be at the zero bound), the fiscal authority could issue as much cash as it wants, so why couldn't it issue as many bonds as it wants? After all, at the zero bound the two are equivalent. Hence Japan continues to defy predictions of doom despite ongoing debt issuance.

Carrying the argument further, the illusion of a difference between cash and debt at the zero bound is counterproductive because it prevents the full application of fiscal policy. Fears about the magnitude of the government debt prevent sufficient fiscal policy, but such fears are not rational if debt and cash are perfect substitutes. If cash and debt are the same, the fiscal authority should prefer to issue cash if debt concerns create a false barrier to fiscal policy. Still, I would argue that this is best done in cooperation with the monetary authority. Note that this is not really a new idea, as then Governor Ben Bernanke drew a similar conclusion with regards to Japan:

However, besides possibly inconsistent application of fiscal stimulus, another reason for weak fiscal effects in Japan may be the well-publicized size of the government debt...In addition to making policymakers more reluctant to use expansionary fiscal policies in the first place, Japan's large national debt may dilute the effect of fiscal policies in those instances when they are used....My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt--so that the tax cut is in effect financed by money creation.

And then we come to the platinum coin, which threatened to expose the illusion that cash and debt are different at the zero bound. By extension, the platinum coin threatened to expose as folly any near-term deficit reduction plan. If you could issue a coin to support near term spending without inflationary consequences, what exactly is the rational for tighter policy now? There is none - but that would run directly contrary to the conventional wisdom among Very Serious People on both sides of the aisle that the debt needs to be addressed right now.

And just think about what it would mean for the Fed if it became evident that, even if only temporarily at the zero bound, deficit spending could be monetized with no impact on inflation. The lines between monetary and fiscal policy would blur further, threatening the existing state of affairs in Washington. Monetary policymakers would face an increasingly hard time defending their need for independence as akin to an Eleventh Commandment.

Ultimately, I don't believe deficit spending should be directly monetized as I believe that Paul Krugman is correct - at some point in the future, the US economy will hopefully exit the zero bound, and at that point cash and government debt will not longer be perfect substitutes. Note that Greg Ip disagreed with this point:

I disagree. The Fed does not have to sell its bonds, or the $1 trillion coin, to control inflation (though it may do so anyway). It only needs to retain control of interest rates, and that does not depend on the size of its balance sheet.

Ip argues that interest on reserves gives the Fed the power to control interest rates, and consequently the power to control inflation, regardless of the size of the balance sheet. If you follow Ip's analysis through to its logical conclusion, then why should the Treasury issue debt at all? Why not just issue platinum coins? Could cash and government debt combine to serve the same functions together that they serve separately? Consider the disruptiveness of that outcome to the status quo.

Bottom Line: The platinum coin idea was ultimately doomed to failure because neither the Federal Reserve nor the Treasury could allow for even the remote possibility it might be successful. Its success would not just alter the political dynamic by removing the the debt ceiling as a threat. The success of a platinum coin would fundamentally alter the conventional wisdom about the proper separation of fiscal and monetary policy and the need to control the debt immediately.

[ProdigyofZen]

Re: John Rubino: Has The Debt Jubilee Already Started?

http://www.financialsense.com/contri...lready-started

This is very much in line with my recent thinking on the subject. If QE is extended into perpetuity, any bonds thus bought being rolled over forever on the central bank’s balance sheet, the effect is equivalent to a public debt jubilee, since any interest paid on the bonds will be returned to the treasury, as if the debt paper isn’t there. The public sector then can propagate it’s renewed financial robustness into the private sector either by engaging in stimulus spending or by lowering taxes now or communicating to do so in the future. Of course it can also do a formal debt-jubilee based on public sector funding.
What I’m wondering about is whether this will in the end create net inflation. I understand that debts to a certain extent confer a disinflationary pressure on consumer prices and this counteracts that. But haven’t central banks in the past lowered interest rates to counteract the debt-deflation and won’t they need to raise them again to make the situation inflation neutral? Can they do that, or is their balance sheet too much impaired? Raising interest rates requires the sale of assets, right? Do they have enough of them?

I have been contemplating for years that government bond markets do not need to exist. Although I think bond markets are the equalizer that keeps governments from over creating money and a collapse.

The example I give is: let's say a new nation starts up, brand new, similar to the Latin American countries in the 1800s that were formed.

Where does the government get money? Do they call up China on their red phone and ask to borrow 10 billion in Chinese Yuan to then convert into their currency and circulate that into their banks and economy?

Sounds ridiculous to me, no? The government or CB simply creates the capital stock of the nation. They don't need to borrow on the international markets. Why is a bond market needed?

There are plenty of nations that operate without bond markets.

So let's look at Bolivia. http://www.bloomberg.com/news/2013-0...es-credit.html

In Oct they issued their first sovereign debt in over a century. It is dollar denominated yielding 4.875% due in 2022 and was oversubscribed by 8x.

So how did Bolivia operate without the government borrowing in the bond market? Export earnings.

As long as Bolivia can continue to earn enough US dollars from export earnings then they will have enough US dollar reserves to cover their debt payments and can continue issuing US dollar denominated debt.

They will run into trouble if their interest rates rise and they dont have enough foreign dollar reserves to cover sovereign debt payments.

They backed the entire country into a corner by issuing US dollar denominated debt instead of Boliviano denominated debt.

These low yields arent just in the US but worldwide. When interest rates begin to rise in the US they will rise internationally and you are going to see massive sovereign defaults a few years after I rates begin to rise.

[ProdigyofZen]

Re: John Rubino: Has The Debt Jubilee Already Started?

Wow, it just dawned on me that I've come around to viewing things exactly how EJ explained it when I asked "how can the government get out of debt by borrowing" a few months ago. It's really, really easy when they have the central bank on their side.

Could you copy and paste EJ's response to the question you asked him?

[NCR85]

Re: John Rubino: Has The Debt Jubilee Already Started?

I think the important thing to realize is that what I'm describing is an unconventional situation that is not "supposed" to go in effect under the "design" of the system. The Fed is *supposed* to be a temporary player in the market. Only if it becomes a permanent player, generating the demand for treasury paper on it's own power and sustaining that demand forever, it's actions become equivalent to monetization. At *that* point it might as well rip the treasury paper on its balance sheet up, but doing so is a cosmetic act only. What's really interesting is how fluid the transfer from the "normal" situation to the "cheating" situation is. There is no one that suddenly decides "now we're going to monetize the whole lot". It happens naturally by virtue of the fact that the Fed stops being able to exit the market without destroying the government's (and FIRE sector's) finances, or inflating the currency.

I think to say that the bond market is unnecessary is to jump ahead to assuming the game gets cheated on. Though I'll grant that it's far from an absurd assumption.

[NCR85]

Re: John Rubino: Has The Debt Jubilee Already Started?

The decision to monetize is really made on congress' end. When congress decides to spend so much that the Fed will be forced to stay in the market, monetization has begun.

It's quite likely that in some future mid-output-gap crisis, there will be a point at which congress gets to decide between deflation and inflation: do another TARP in the knowledge that only monetization can fund it, or let the banking system collapse with deflationary consequences.

My money would be on monetization-based TARP2.

[NCR85]

Re: John Rubino: Has The Debt Jubilee Already Started?

OK, I’m beginning to see a weakness in this argument.


Interest paid to the central bank is interest that is not paid to the private sector.


Hence, any transfers of interest from the central bank to the government as a result of seigniorage is really a transfer from the private sector back to the government. The effect is probably net-neutral.
There is a small reason to view the transfer as positive to economic growth regardless, because it raises the prospect of lesser taxation, which by itself is allegedly good for growth (again this is something not beyond dispute, but let’s allow it for the moment; short story: taxing the parasitic FIRE sector isn't so bad). But it is a much smaller scale effect than an outright “monetization” would confer.

[ProdigyofZen]

Re: John Rubino: Has The Debt Jubilee Already Started?

OK, I’m beginning to see a weakness in this argument.


Interest paid to the central bank is interest that is not paid to the private sector.


Hence, any transfers of interest from the central bank to the government as a result of seigniorage is really a transfer from the private sector back to the government. The effect is probably net-neutral.
There is a small reason to view the transfer as positive to economic growth regardless, because it raises the prospect of lesser taxation, which by itself is allegedly good for growth (again this is something not beyond dispute, but let’s allow it for the moment; short story: taxing the parasitic FIRE sector isn't so bad). But it is a much smaller scale effect than an outright “monetization” would confer.

A weakness in my argument or the one you proposed NCR?

[NCR85]

Re: John Rubino: Has The Debt Jubilee Already Started?

OK, I’m beginning to see a weakness in this argument.


Interest paid to the central bank is interest that is not paid to the private sector.

WRONG! (or rather, technically right, but not a good argument!)

Wow.

They remove interest payments to the private sector, yes. But in so doing they pay a higher price for the bonds than the owners of the bonds would otherwise have gotten. So anything lost by the bond holders in terms of interest income is gained in the form of capital appreciation.

[BadJuju]

Re: John Rubino: Has The Debt Jubilee Already Started?

Yeah! You show 'em, NCR85!

[NCR85]

Re: John Rubino: Has The Debt Jubilee Already Started?

Edward Harrison calls this the consolidated balance sheet approach to monetary and fiscal policy:

http://www.creditwritedowns.com/2013...-sheet-qe.html

I like the name.

[don]

Has The Debt Jubilee Already Started?

for some . . .

[gwynedd1]

Re: Has The Debt Jubilee Already Started?

Government debt always did the duck walk of money.