Going right to the top in Europe

I woke up to the headlines this morning about the apparently failed German bond tender yesterday and all the experts predicting doom. In my E-mail box there was around 30 requests for an explanation from readers who had read the news and concluded that it was a major event in the current crisis but didn’t really understand what the implications were. The implications are fairly simple – the bond markets are working out that no EMU government is free of insolvency risk because they all use a foreign currency (the Euro). Germany is better placed to resist the crisis because of the relative strength of its economy but it is not immune from it. Its economy will also deteriorate as the effects of austerity spread out through trade. While the “experts” waxed lyrical about the crisis being confined to profligate EMU states (the PIIGS), it was always clear that the northern strong-hold states were going to be dragged in as the crisis deepened. That is because the problem is the Euro itself and the way the monetary system is designed. All the other emotional stuff about lazy Greeks is a sideshow. Germany is starting to find that out – yesterday, it received its first strong message. The crisis is going right to the top in Europe now.

The news was clear – that the German government’s latest 10-year Bund tender (auction) had failed and according to this Irish Times article (November 23, 2011) – Crisis hits German bond issue – the Euro crisis was finally knocking on heaven’s door.

The Irish Times quoted the head of the Deutsche Finanzagentur, which is the German government finance agency that manages the German debt issuance process as saying that the shortfall in bids for the 10-year bond issue was “mainly due to extremely nervous markets and not a sign of falling investor demand for German debt”.

As we will see:

Germany had hoped to sell €6 billion of debt, but commercial banks bought just €3.644 billion and the debt agency retained a larger-than-usual portion, making it one of its least successful debt sales since the launch of the euro.

The retained amount, roughly 39 per cent of the planned volume, will be sold in the secondary market.

What does this all mean?


1. The cost of funding German deficits has risen (because the secondary bond market sales will be at a greater discount). Even though the yield yesterday was 1.98 (average) which was down on the 2.09 per cent achieved in the October auction, the reality is that this was engineered by the Deutsche Finanzagentur as I will explain.

2. The bond markets are realising that the so-called gold standard of the Euro – the German bund – is only as risk-free as the government that issues it. And it is obvious that the German government is in the same boat as all other EMU member states – it faces insolvency risk because it operates in a foreign currency (the Euro).

Sure enough, the strength of the German economy makes it less of a risk (there is a more robust tax base to plunder) but it is only a matter of degree.

3. We will see more about this in the coming weeks when 3 more auctions are due.

The commentators were interesting. Descriptions such as “This auction is nothing short of a disaster for Germany” and “one shudders concerning the upcoming auctions in other European nations”.

We have been seeing the pressures building for some months now – snaking across the weaker southern EMU states and more recently into larger economies such as Italy and then France.

Now it is going right to the top.

Meanwhile the European Commission president José Manuel Barroso was busily outlining the latest EC plan to salvage Europe from the crisis. Like all other plans it will fail and in the meantime will further erode democracy. I will blog about this plan another day.

Basically it is setting up a centralised surveillance unit to further usurp the fiscal capacity of the member states without at the same time establishing a fully-fledged “federal” fiscal capacity to meet asymmetric aggregate demand shocks (across the region).

The plan would require all member states (17 nations) to send draft budgets to the EC by October 15 each year. The Commission could then reject the plan and force the nation to alter the spending and taxation proposals. There would also be stricter rules under the “Excessive Deficit Procedure” which would seek to enforce the Stability and Growth Pact more closely.

All member states would be forced to set up “independent fiscal councils” which would be involved in the preparation of budgets and official forecasts.

If a nation needed financial assistance there would be federal support it would have to be obedient under these rules.

Short conclusion: it would be a total disaster.

Slightly longer conclusion: if this framework had have been in place in 2007, the outcome now would have been even worse because the initial surge in deficits would probably have been short-circuited. If not, then Europe would be in the same situation as today.

More on this another day.

But back to the German bond issue story.

While I am most familiar with the Australian institutional structure, bond issuance (in primary markets) is organised along similar lines in all countries.

A primary market is the institutional machinery via which the government sells debt to “raise funds”. Remember that the term “funding” is loaded given that sovereign governments do not strictly have to borrow to run deficits. However, in the German case funding has the more traditional connotation given the country uses a foreign currency (the Euro).

A secondary market is where existing financial assets are traded by interested parties. So newly-issued government bonds enter the monetary system via the primary market and are then available for trading in the secondary. The same structure applies to private share issues for example. The company raises funds via the primary issuance process then its shares are traded in secondary markets.

However, new issues can also enter the secondary market via the “back door” and I will explain what that means later.

Clearly secondary market trading has no impact at all on the volume of financial assets in the system and just shuffles the wealth between wealth-holders. In the context of public debt issuance – the transactions in the primary market are vertical (net financial assets are created or destroyed) and the secondary market transactions are all horizontal (no new financial assets are created). Please read my blog – Deficit spending 101 – Part 3 – for more discussion on this point.

Methods of selling government debt into the primary market vary but the two most known methods are tap and tender. A tap system involves the government setting the yield and selling as much debt as is demanded at that yield.

Typically governments would be doing this on a continuous basis and adjusting the yields up or down to meet the market requirements and ensure that there were no discrepancies between net spending and bond sale revenue, apart from small volumes that they “buy” themselves and use, in the words of the Deutsche Finanzagentur to smooth out liquidity when a given asset is “a little stretched”.

The “auction” or “tender” system – is the ultimate neo-liberal development and attempts to take all discretion away from the elected government as to what it would pay on government debt issuance.

In this blog – Will we really pay higher interest rates? – I go into this issue in more detail (although the discussion is Australian-centric) and show that the move from tap to an increased reliance on auctions was was driven by the ideological calls for “fiscal discipline” and the growing influence of the credit rating agencies. Accordingly, all net spending had to be fully placed in the private market $-for-$. A purely voluntary constraint on the government and a waste of time.

Typically, the Treasury determines when a tender will open and the type of debt instrument to be issued. They will usually announce the maturity (how long the bond would exist for), the coupon rate (the interest return on the bond) and the volume (how many bonds) of the assets being put up for auction.

The following diagram is sourced from Deutsche Finanzagentur and shows the process which is followed to determine the parameters and execution of each auction.

As you can see, the German government via the Deutsche Finanzagentur announces the parameters for the issue (maturity, volume and coupon) on the Thursday morning the week before the Wednesday morning auction (in relation to the Bunds). The morning before the auction (Tuesday) the Government invites bids for the issue which must specify the “price” that the buyer is prepared to pay (expressed in terms of the discount to the coupon).

On the auction day (Wednesday), the Deutsche Finanzagentur announces the allocation according to the bids received and what portion they are retaining for “secondary market operations”.

In a general case, once the Government invites bids for the tender, the market then determined the final price of the bonds issued. Imagine a $1000 bond had a coupon of 5 per cent per annum, meaning that you would get $50 dollar per annum until the bond matured at which time you would get $1000 back.

Imagine that the market wanted a yield of 6 per cent to accomodate risk expectations. So for them the bond is unattractive and they would avoid it under the tap system. But under the tender or auction system they would put in a purchase bid lower than the $1000 to ensure they get the 6 per cent return they sought.
The mathematical formulae to compute the desired (lower) price is quite tricky and you can look it up in a finance book.

The general rule for fixed-income bonds is that when the prices rise, the yield falls and vice versa. Thus, the price of a bond can change in the market place according to interest rate fluctuations.

When interest rates rise, the price of previously issued bonds fall because they are less attractive in comparison to the newly issued bonds, which are offering a higher coupon rates (reflecting current interest rates).

When interest rates fall, the price of older bonds increase, becoming more attractive as newly issued bonds offer a lower coupon rate than the older higher coupon rated bonds.

For new bond issues, the Deutsche Finanzagentur currently (2011) recognises 33 institutions which are included in the 2011 Bund Issues Auction Group.

The list in the linked document is ranked in order of the “issue amounts – weighted according to the different maturities and the related interest rate risks – which they took over in 2010”.

So the top 5 were:

Deutsche Bank Aktiengesellschaft
The Royal Bank of Scotland plc Niederlassung Frankfurt
Citigroup Global Markets Limited
UBS Deutschland AG
Goldman Sachs International

In terms of the weightings, it will be of no surprise that a 10-year Bund is weighted 15 while the 6-month Treasury discount paper (Bubills) are weighted 1.

The Deutsche Finanzagentur deals exclusively with this group for primary issues.

The Bond Auction procedure used by the Deutsche Finanzagentur (outlined in the diagram above) is similar to that in use everywhere. You can also read more about the Terms of the Auctions.

We read that the “auctions are carried out via the Deutsche Bundesbank Bund Bidding System (BBS)” and members of the Bond Issuance Auction Group have to bid in units of:

… at least 1 million, or a full multiple thereof, and should state the price, expressed as a percentage of the nominal amount, at which the bidders are prepared to buy the securities offered. In principle, it is possible to enter several bids at different prices and/or to make non-competitive bids. The prices bid must be for a full 0.01 percentage point for Bunds and Bobls …

The Bund uses a multiple price auction procedure. In other words, bids for Bunds … accepted by the German Federal Government are allocated at the price quoted in the respective bid and are not settled at a uniform price. Bids priced above the lowest accepted price are allotted in full, while bids priced below the lowest accepted price receive no allotment. Non-competitive bids are allotted at the weighted average price of the accepted price bids. The Federal Government reserves the right to re-allot the bids at the lowest accepted price as well as the non competitive bids, e.g. to allot them only at a certain percentage rate.

More detailed information about the way the auction is conducted is available from the German Bundesbank (its central bank). We read that bids “should state the price, as a percentage of the par value, at which the bidders are prepared to purchase the Federal securities offered”.

So the German government ranks the bids received in terms of price (and implied yields desired) and a quantity requested in millions of Euros.

The bonds are then issued in highest price bid order until the total auction volume is exhausted or, importantly for the auction yesterday, they exhaust the allowable bids.

So the first bidder with the highest price (lowest yield) gets what they want (as long as it doesn’t exhaust the whole tender, which is not likely). Then the second bidder (higher yield) and so on.

In this way, if demand for the tender is low, the final yields will be higher and vice versa. There are a lot of myths peddled in the financial press about this. Rising yields may indicate a rising sense of risk (mostly from future inflation although sovereign credit ratings will influence this). But they may also indicated a recovering economy where people are more confident investing in commercial paper (for higher returns) and so they demand less of the “lower” “risk” government paper.

Clearly, the paper issued by member governments within the EMU does carry risk whereas paper issued by sovereign governments that issue there own currency can be considered risk free.

Please read my blog – Time to outlaw the credit rating agencies – for a background discussion on the technical matters pertaining to bond issues.

The Deutsche Finanzagentur publishes all the bond auction results – here are the 2011 results to date.

The following table shows the 2011 results for the 10-year Bunds only – given it was this auction yesterday that apparently failed. I edited some of the extraneous information out of the official table to allow the data to fit into the screen and be readable.

If you study the data (and understand it) it is not hard to work out what happened yesterday. First, a clarification. Several readers asked me about the bid-cover ratio which was reported as being 1.1. They asserted that this meant it was a lie to say the bond auction failed and that the German government could have sold more debt (in value terms) than they required (6 billion Euros).

I explain bid/cover ratios in this blog – D for debt bomb; D for drivel ….

The bid-to-cover ratio is typically taken to be the volume (in currency units) of the bids received to the total volumes (in currency units) desired. So if the government wanted to place $20 million of debt and there were bids of $40 million in the markets then the bid-to-cover ratio would be 2.

For sovereign governments clearly the bid ratio is somewhat irrelevant because it could just abandon the auction system whenever it wanted to if the ratio fell to 0.00001.

The ratio is does not provide a clear signal. It certainly signals strength of demand but how strong becomes an emotional/ideological/political matter. Even if you believed that the government was financing its net spending by borrowing, then a bid-to-cover ratio of one would be fine – enough lenders to cover the issue. Some commentators think that 2 is a magic line below which disaster is imminent. There is no basis at all for that.

For reasons that are not explained, the Deutsche Finanzagentur defines the bid/cover ratio differently to the standard practice. It says the bid/cover ratio is calculated as the:

Relation of the demand to the alloted volume.

Note the subtle difference. Usually, it is the ratio of bids to total auction volume. In Germany’s case, the official data is referring to the number of bids to the amount the Government actually issues, which could be (as it was yesterday) well below what it desired to issue.

So the 1.1 for yesterday’s auction refers to the fact that there were nominal bids worth 3,889 million Euros and allotments were equal to 3644.00 million Euros.

The conclusion that the German government “could have” met their auction target if it wanted to is thus false.

If you examine the 2011 results closely, you will see that when the average yield is above the advertised coupon, the “lowest accepted price” is below 100 (meaning the lowest bid received was at a discount to par).

Similarly, when the average yield is below the coupon, the lowest accepted price is above 100 (above par).

You will note (second-last column) that there is an amount retained by the Government for “secondary market operations”. What does that mean?

The Deutsche Finanzagentur provide some insight into their Secondary Market operations.

They say that:

In addition, the German Federal Government Finance Agency supports the market makers’ presence in the secondary market by helping out in case if needed, e.g. in exceptional cases when the liquidity of a given security should become a little stretched. For these purposes the German Finance Agency retains on its own books a certain portion of the nominal amount tendered at the auction of a new or reopened issue.

The following graph shows the amounts retained by the Deutsche Finanzagentur for secondary bond market purposes from 2006 to 2011 (yesterday) (it relates only to the 10-year Bund). The spike at the right of the graph was yesterday. The green line is the average over the entire period 1161.4 million Euros and the average for 2011 is so far 844 million Euros (excluding yesterday’s volume).

By any logic, yesterday’s withdrawal by the Government is an outlier and goes well beyond what they need for “operational” purposes (to ease an asset class that is a “little stretched” for liquidity in the secondary markets).

Finally, it is clear that the nominal bids for yesterday’s auction were 3,889 million Euros while the government was after 6,000 million (less some amount of their secondary market operations tranche (which has averaged before yesterday 844 million Euros).

So the bids were 65 per cent of the volume for auction. If we took out the average secondary market tranche for 2011 then the bids received would climb to 75 per cent of the volume up for auction.

Why then did they only allocate 3,644 millions of the desired volume (some 61 per cent or 71 per cent if you take into account the average secondary market tranche)?

The answer is that they wanted to keep the yield down around the coupon rate of 2 per cent and so had to cut off the bids (the prices that the auction group were prepared to pay) at around par.

Clearly, the remaining bids were trying to push yields up and the Government resisted that market trend.

So to achieve the desired yield they “purchased” 2,356 million Euros-worth of the issue which they will then seek to sell in the secondary market.


I laughed (schadenfreude) when I looked at the data this morning. The German government is manipulating its own rules – by withdrawing much more to sell in secondary markets than it could justify for operational reasons.

They did this to:

1. Keep the official Bund yields low.

2. Bail itself out when the bond markets are not willing to fund it on their terms – or in yesterday’s case – not even fund it on any terms.

While the Germans are preaching to all and sundry about their insistence that the ECB should not be funding government deficits, what the Germans did yesterday is not that far removed from that.

The story has more to go yet though because the Euro crisis is heading right into the core. As the world economy slows again as a result of the deliberate policy choices of governments who seem to want to be vandals rather than govern, the German export machine will contract.

By then the private bond markets will have been attacking France and heading due East.

That is enough for today!

This Post Has 35 Comments

  1. The note of gallows humour in the posts is getting stronger it seems. I take it the ‘Train is about to crash and I am powerless to stop it’ feeling is growing…

  2. Good description overall except for the conclusions!

    “2. Bail itself out when the bond markets are not willing to fund it on their terms – or in yesterday’s case – not even fund it on any terms.

    While the Germans are preaching to all and sundry about their insistence that the ECB should not be funding government deficits, what the Germans did yesterday is not that far removed from that.”

    No hanky panky happening there!

    There is absolutely no reason a big deal should be made out of this.

  3. Thanks, you found some essential details I didn’t see elsewhere. Also .. the length is short enough to make it an easier read than your usuals ;^)

  4. OMG. Bill… Thank you… thank you… thank you. This fills a major gap in my econ/finance education – as yet unofficial, but to begin in earnest in 2012. I have always wanted to know about this process, and in the absence of scouring through older posts you referenced, today’s was golden for all you explained and for toward guidance further details. AWE+SOME. Cheers.

  5. I still say they should write “PIIGS” as “GIPSIs”. It’s so much more in keeping with the continent’s history of zenophobia.

  6. Bundesbank publishes an average yield of german publich debt. It is called “Umlaufrendite”. It dropped from above 5.0 % in 2002 to 1.5 % a few weeks ago. Now it is well above 1.8 %. Look at this Chart


    Therefore I consider your following statement as absurd: “The story has more to go yet though because the Euro crisis is heading right into the core. “

  7. “Therefore I consider your following statement as absurd: “The story has more to go yet though because the Euro crisis is heading right into the core. “”

    You and seemingly most of the German population. That is precisely the problem.

  8. Dear Dr. Oliver Strebel (at 2011/11/25 at 2:28)

    And what were the bid yields (prices) that the Deutsche Finanzagentur rejected on Wednesday when they stopped the allotted lowest yield at just above par and “bought” a record amount themselves for “secondary bond market operations”? They don’t make that information publicly available.

    And what will be the discounts they have to wear when they offload that “record withdrawal” in the secondary markets?

    Clearly they managed to keep publicly available yields on primary issue low – by “buying up the debt themselves”. Time will tell.

    best wishes

  9. This was exactly what I was looking for! A German had told the Bundesbank acted as a resort lender. It’s not the Bundesbank, but they have a manipulation mechanism as well 🙂

  10. “While the Germans are preaching to all and sundry about their insistence that the ECB should not be funding government deficits, what the Germans did yesterday is not that far removed from that”

    I’d say it’s somewhat removed from that, at least operationally. The government could only do what it did if it already had sufficient cash in its deposit account at BUBA. That’s what allowed it to hold back more bond issuance than usual, thereby allowing it flexibility in effective timing of bond issuance, and in managing the effective yield cost. And that sort of cash position is the inverse of the ECB funding it. There was no new cash associated with the bond holdback.

    That’s not to say in time they won’t end up being funded at the ECB. But what they did here is an indication of operating cash strength, not weakness. They have not yet received the memo from Warren Mosler to the effect that “governments neither have nor don’t have money”.

  11. Dear JKH (at 2011/11/25 at 7:48)

    Yes it is different but the point is that they were deliberately manipulating the allotments to ensure the bids remained just above par to hold down yields on the primary issue. They will have to sell much of it in the secondary markets and then unless the ECB does buy a significant tranche of it the yields will rise.

    The weakness that the auction demonstrated was the lack of bids at the price they wanted.

    Further, Warren’s pithy description is applicable only to fully sovereign governments not to governments that use foreign currencies such as Germany. Ultimately, they could (I don’t suspect they will) find themselves not having (enough) money to fund their operations.

    best wishes

  12. Dear Dr Oliver Strebel (at 2011/11/25 at 7:58)

    I realise it was not “bought” by the BUBA which is why I put it in inverted commas to make that clear. I understand how the German system operates and that it is normal for them to not allot the full tender. But one cannot escape from the facts:

    1. The total bids (in millions of euros) were well below the auction volume desired.

    2. The DF rejected some of the bids to manage the yield.

    3. The amount retained for secondary market operations was historically high and well beyond anything like what they would need for normal market smoothing.

    Once they release that retained allotment the yields will rise unless the ECB buys up the paper and then funds the deficit.

    It was not a normal auction outcome. That is the point.

    best wishes

  13. Bill,

    I agree with your points.

    My connection to Warren’s characterization of fully sovereign governments was in part an attempt at subtlety as regards current European circumstances. The way things stand now, I would say that Germany has the political potential for effective monetary sovereignty over the ECB (as it operates in Euros) almost as much as the US Congress has over the Fed. Germany is really the critical actor now standing in the way of a full ECB backstop for the Euro and its various sovereign clients at this point. If Germany accedes, then the ECB will be able to provide the type of direct assurance to Euro markets that the Fed is implicitly understood to provide to the US by virtue of the more direct form of US sovereignty over it. So in that sense, if Germany accedes to the idea of a more comprehensive ECB backstop, they will in a way have seen the memo by then.

  14. Germany wants it both ways — they want an “auction” where the market sets the price. But they also want to manage the price by cutting the auction off at whatever point the yield goes too high. Fine. But that’s hardly what you can call a free market.

  15. http://www.counterpunch.org/2011/11/24/the-roads-to-war-and-economic-collapse/

    November 23, 2011: The day before the Thanksgiving holiday brought three extraordinary news items. One was the report on the Republican presidential campaign debate. One was the Russian President’s statement about his country’s response to Washington’s missile bases surrounding his country. And one was the failure of a German government bond auction.

    As the presstitute media will not inform us of what any of this means, let me try…

    Why would Germany, the only member of the EU with financial rectitude, not be able to sell 35 per cent of its offerings of 10-year bonds? Germany has no debt problems, and its economy is expected by EU and US authorities to bear the lion’s share of the bailout of the EU member countries that do lack financial rectitude.

    I suspect that the answer to this question is that the failure of the German government’s bond auction was orchestrated by the US, by EU authorities, especially the European Central Bank, and private banks in order to punish Germany for obstructing the purchase of EU member countries’ sovereign debt by the European Central Bank.

    The German government has been trying to defend the terms on which Germany gave up control over its own currency and joined the EU. By insisting on the legality of the agreements, Germany has been standing in the way of the ECB behaving like the US Federal Reserve and monetizing the debt of member governments.

    From the beginning the EU was a conspiracy against Germany. If Germany remains in the EU, Germany will be destroyed. It will lose its political and economic sovereignty, and its economy will be bled in behalf of the fiscally irresponsible members of the EU.

    If Greeks will not submit to the tyranny, why should Germans?

  16. I wasn’t sure where to post this set of questions and ruminations so I have posted them on the latest topic. I hope it is not inappropriate here.

    MMT in General

    I am in a position where my thoughts are perhaps halfway between MMT and Keynesian economics. I find MMT a breath of fresh air as I have become enormously frustrated with the refusal or inability of current conventional (neoliberal and really non-Keynesian) economics to tackle our most pressing economic problems. These most pressing problems are unemployment, capacity under-utilisation, stagnation of wages, excess profits to the capitalist class, excess speculation and asset price bubbles to name the main culprits. I find particularly infuriating (there is no other word for it) the refusal, by the mainstream, to countenance and implement persisting government deficit spending at least until full capacity utilisation is achieved.

    However, I have some problems with MMT where I feel it goes “too far” in some of its claims. Perhaps this is just caused by limitations in my understanding. I hope I can question some of the claims of MMT here in order to get answers and learn. My yardstick for acceptance of economic ideas is that each idea must accord so far as I can tell with the empirical reality of a modern fiat currency system and the real economy system insofar as I understand those systems. I will nominate two key descriptive MMT claims I have found (and which may or may not be genuinely representative of MMT thought) and then add my own commentary. The way some MMT advocates word their claims can perhaps lay them open to scepticism. Therefore I will not sanitise the common and I think representative wordings of their claims. Rather, I will include discussion of this in my commentary. Remember, I make my comments in an enquiring spirit, not to gratuitously slight MMT or its advocates. In my attempts to nut things out on my own without much book learning in economics I might get a little “faux philosophical” so please bear with me.

    MMT Descriptive Claim 1

    Tax is levied by the government in order to create demand for its fiat currency. In addition, it controls aggregate demand or effectively, the money supply.

    Commentary on 1

    The first sentence of this description implies conscious design intent and consensus about such conscious design among “those” (a vague and difficult to define group dispersed geographically and temporally) with the presumed power to implement, maintain and amend such a system over time. Such a statement takes no cognizance of the characteristics of socially evolved systems among which we might count the possibility that a system ostensibly developed for one purpose in one age may evolve and even transform complexly and emergently to meet an old purpose in a new way or new purposes in new ways. The ongoing controversy about the full purpose of taxation and the fact that MMT is a minority view is evidence enough in itself that no such conscious design intent is a matter of general consensus or acceptance. This in itself does not debunk the MMT descriptive assertion but suggests if it is true it might not be complete and that the asserted “purpose” or effective result might not be the one most immediately apparent to most general observers.

    As such, it should have been worded more cautiously as follows. “Tax levied by a fiat currency issuing government functions domestically to create demand for its fiat currency at least for the purpose of extinguishing tax liabilities. This does not exhaust the functions of tax. Another function is to control aggregate demand or effectively, the money supply.” Orthodox (neoliberal) economists might not wave both of these assertions through the checkpoint but I suspect that most would wave the second one through. However, I am sure all would then raise the issue that the most important (to their minds) purpose of taxation is not even a passenger in the MMT vehicle. This purpose is to fund government activity.

    MMT advocates prefer to see the issue with a different causal order. They prefer to see government as creating the fiat currency for government expenditure in total at the beginning of the budget cycle and to see taxed monies as extinguished at the end of the government cycle. To me this seems a rhetorical device on the part of MMT. It is of benefit to see it this way if you are advocating some unfunded deficit spending. It helps break the orthodox dogma that even modest deficits must always be “funded” eventually over many cycles. However, the claim that taxation does not support the bulk of government activity (as acquisition of goods and services from the private sector) does not survive an empirical examination in my opinion (so far as my opinions are developed to date).

    As a wage or other income earner, I might receive 100 units of income over the year. The government might levy 30 units of tax from me. This reduces my monies available for personal expenditure to 70 units a year. This frees up 30 units worth of goods that the government may purchase without adding to aggregate demand. This answers in the affirmative the assertion that aggregate demand has been controlled i.e. effectively kept the same in this case. But it goes further than this. It indicates that a proportion of my productive power, 30%, (as currently valued by the market economy) has been levied or appropriated from me and applied to a government purpose. The real goods (or services) can be and are appropriated too. A new second motor vehicle which I might have indulged in for purely selfish recreational purposes can now be a government vehicle serving a genuine and good public purpose.

    I see no reason that all three of these functions for tax and possibly even more cannot be concurrently true. “Tax supports the bulk of government activity as acquisitions of goods and services from the private sector. As a corollary of its manner of implementation, tax functions to control aggregate demand or effectively, the money supply. Further, tax levied by a fiat currency issuing government functions domestically to create demand for its fiat currency at least for the purpose of extinguishing tax liabilities. This requirement lends such credence, desirability and implied security to a fiat currency in an advanced economy that a specific mandate and enforcement of the status and use of legal tender in the domestic market is not strictly required (and not actually provided for by Australian law). This does not exhaust the practical impacts and functions of taxes in our system. For example, there is the issue of Pigovian taxes.”

    MMT Descriptive Claim 2

    Money must be created before government bond auctions can occur and before taxes can be enforced. Otherwise, there is no currency in the system to tax and no money to raise via bond auctions. This is just basic logic in terms of the way the current system works. It can be no other way.

    Commentary on 2

    Descriptive Claim 2 might be acceptable if the statement is meant in a very pure, simplified theory sense, particularly if hypothetically envisaging the start-up of a new sovereign fiat currency issuing government from scratch. This is the type of example often used by some MMT advocates. However, in the real world, at any point in time, the pre-existence of money and the historical pre-existence of other systems of money (prior to the post gold standard “fiat currency era”) and the consequent carry over and evolution of said money, tax and other financial systems in the pre and post gold standard eras vastly complicates the picture. Much current extant money is certainly pre-existent to the current budget cycle. Much current extant money (in an era of high lending) is not fiat money but bank loaned debt money which is not yet extinguished against the debt by repayment.

    It seems to me that I could go to the (private enterprise) bank and borrow against the equity in my home to pay taxes I might be having trouble paying. These are ledger or account entries, nothing more. My home loan ledger now shows say 10,000 more debt. My savings account temporarily shows 10,000 more credit then reverts to its previous level (very low). My debt to the tax office is expunged. Technically, so far as I can see, the government at the slice of time in question created no more fiat money for me to pay my tax liability. Thus I did not strictly pay fiat money to extinguish the tax debt at that slice in time. I paid bank generated debt money. It is true that this debt money will eventually be expunged by repayment of the debt or the bank writing it off against other assets (probably my repossessed house) if I fail to repay.

    The “persistence” of monies (how long particular monies “persist or exist”) seems to be a tricky question and one that might need answering. I was tempted to say that fiat money, once created persists indefinitely and debt money once created persists only until the debt is repaid. However, it occurs to me that MMT might state formally, in the case of balanced budgets, that all fiat monies persist for one year (the budget cycle) whereupon they are destroyed by taxation and fiat monies are created anew. It seems to me that there is a mathematical equivalence leading to a logical equivalence for the views that (a) fiat monies are created and destroyed in equal proportions by balanced budget cycles or (b) fiat monies taken in tax in balanced budgets are recycled indefinitely while balanced budget cycles subsist.

    Thus, formally speaking, in balanced budgets we can equally regard fiat monies as having a precise life of one year or an indefinite life. At least, I think this might be the case. With debt monies, the only way to look at debt monies must be to consider that they have a half-life (the period of time it takes for the amount undergoing “decay” to decrease by half). Already extant debt monies decay. It is not possible to set a firm end date for many loans as repayment rates can be varied and re-borrowing (to some extent) can occur. The behaviour of many monies from numerous loans, many with a functionally indeterminate termination or full repayment date, all taken out at many different times would be thus be very complex indeed but one assumes this would be be amenabe to an aggregation solution by probability mathematics and (differential?) equations. (I am no mathematician.)

    I am honestly not sure where (if anywhere) my above ruminations lead. The first thing they suggest to me is that governments (under current laws, regulations, practice and ideological management) have far less control of how much debt money is in the system and whether it is growing or decaying than they have of fiat money. Fiat money is under tight control (arguably too tight) constricting government action and popular demand by the many (the 99%) who have votes to vote with but not much money (comparatively) to “vote” with. (I think you get my drift). But debt money is under loose control or out of control. I can only sum that up by asking, “Is this any way to run an economy?”

    Do my ruminations and reservations about MMT suggest any replies?

  17. @Ikonoclast:

    The first point talks about how taxation creates demand for the currency, but implied (and often stated) is that state power is at the core of this demand creation. If there was no penalty for not paying taxes, then it would not work. So the concept of a currency having value because it is simply declared “legal tender” and must be accepted for all debts private and public – that’s state power once again. So really, state currency has value because the state has a court system and cops to back it up.

    Check out https://billmitchell.org/blog/?p=5762 and the first answer to this saturday quiz:
    Bill talks about how taxation moves resources from the private to public domain, just like in your car example.

    When it comes to the difference between fiat and bank created currency, the key idea is “net financial assets”. Here’s a blog that touches on this: https://billmitchell.org/blog/?p=11218. The basic idea is that banks cannot create NFA, only deficit spending can. Since not all money passes through the government in a year, it is impossible to say that fiat money only lasts a year. It’s best not to get bogged down in how long a dollar lasts – MMT is a macroeconomic framework, and concerns itself with all the money in aggregate.

    As for pre-existing currency, that is an interesting question. I’ve never heard Bill discuss it, but here is an essay from 1913 about the topic:

  18. Bill,

    Great work yet again. This site and Pragcap are the only two I read for my regular MMT dose of reality.

    I have one question (which I will open to all other reader)…..

    I have come to believe government deficits, which spend money into existence, essentially represents private sector equity, which in turns helps the private sector (banks) to create credit money without causing financial instability (although does not guarantee it).

    Does this mean the Euro system does not have any “private sector equity”. And all Euro money is essentially credit money?

    I hope this question makes sense.

  19. @Ikonoclast

    Re: paying taxes with bank money. The bank actually pays your taxes with fiat money, on your behalf. If you borrowed money to pay your taxes, you are left with a liability to the bank, rather than to the government, and the bank’s reserve account at the central bank is reduced as your tax payment is processed, while the bank gains an offsetting asset (your promise to repay the bank).

    So tax payments are ultimately settled in fiat money, despite the appearance of you having used bank money to pay taxes.

  20. ParadigmShift, thank you, you definitely seem to be right. Once I think it over and find no holes I will be sure you are right. I appreciate your answer and Grigory’s answer which have both cleared some of my misunderstandings.

  21. JKH,


    The German government may have €250-300 billion in domestic assets (deposits with private banks) and foreign assets combined as per data available. That was its backstop – leading it to reject record bids.

  22. Ramanan,

    Excellent data digging by yourself on that, which I saw afterwords. Confirmed what I thought must be the case.

  23. JKH,

    Thanks. Also, I believe even other governments in the Euro Area do that.

    So one hears of the Spanish government alloted bids less than the maximum amount mentioned prior to the auction. The German auction simply got some attention due to the language it used and some minor differences with others.

    If the Spain (government) were to do it, i.e., raise only €3 billion in an auction instead of the declared maximum €5 billion, it would tell Bloomberg and Reuters (among others) that the issue with ISIN x is sized €3 billion. The German government seems to do something different – even if it raises €3b, it will say that the size is €5b, and that €2b was retained and later try to sell the €2b directly in the secondary markets. But, at no point in time is the €2b in the Bundesbank’s balance sheet. Spain, on the other hand will issue securities with new ISINs for the €2b or merge it with another issuance.

  24. Perhaps the tender volume was made deliberately larger than what would be needed from the Primary Market ? Can there be any explanation besides an regretful breaking of the rules ?

  25. The gyration of the Germans are hilarious. How can they expect to hide their silly attempts at manipulating perception?

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