Well, as I write this late in the Kyoto afternoon, Donald Trump has just made…
Why do currency-issuing governments issue debt? – Part 2
This is Part 2 of the two-part series which focuses on the question: If governments are not financially constrained in their spending why do they issue debt? Part 1 focused on the historical transition of the monetary system from gold standards to the modern fiat currency systems and we learned that the necessity to issue public debt disappeared as fixed exchange rates and convertibility was abandoned in the early 1970s. However, there are many justifications for continuing to issue debt that circulate. In this Part, I consider those justifications and conclude that the on-going practice of government’s issuing debt to the non-government sector is primarily an exercise in corporate welfare and should not be part of a progressive policy set.
There are many other justifications offered for debt-issuance, which do not directly challenging the mainstream economist’s claim that debt-issuance is essential to ‘fund’ a government deficit, but operate somewhat tangential to it.
We learned a lot about these sort of arguments during a particularly enlightening episode in Australian financial history at the turn of the last century.
This is what happened.
We find a hint, in the Australian government’s Budget Paper No 1 for 2012-13, under Statement 7 entitled Future of the Commonwealth Government Securities Market.
The Treasury wrote:
In 2002-03, the Review of the Commonwealth Government Securities Market was undertaken in response to concerns about the future viability of the declining CGS market. Since this review, successive governments have committed to retaining a liquid and efficient CGS market to support the three- and ten-year Treasury Bond futures market, even in the absence of a budget financing requirement.
The term ‘budget financing requirement’ is, of course, not a financial requirement that is intrinsic to the monetary system. It is a voluntarily imposed rule that the sees the Australian government issue debt to match its deficit spending.
The convention could be abandoned at any time without any change in the government’s capacity to spend resulting.
So what was the 2002 Review about.
In 1996, the conservatives won federal office in Australia and built on the neoliberalism of the previous Labor Party by pursuing fiscal surpluses.
The Commonwealth government allowed outstanding debt to mature (and be paid out) and systematically reduced its net debt position as it ran surpluses.
By the end of the Century, the government bond market was becoming ‘thin’, which just means there were much less bonds available for trading in the secondary bond market.
The Government came under pressure from the big financial market institutions (investment banks and other players, particularly the Sydney Futures Exchange) to continue issuing public debt despite the increasing fiscal surpluses.
At the time, the contradiction involved in this position was a talking point although I did a lot of radio interviews trying to get the ridiculous nature of the discussion into the public arena.
The federal government was continually claiming that it was financially constrained and had to issue debt to ‘finance’ itself. But, given they were generating surpluses, then it was clear that according to this logic, further debt-issuance was redundant.
What transpired demonstrated categorically what purpose the debt was serving.
The Government bowed to the pressure from the large financial institutions, and, in December 2002, set up a formal – Debt Review to consider “the issues raised by the significant reduction in Commonwealth general government net debt for the viability of the Commonwealth Government Securities (CGS) market”.
I made a Submission (written with Warren Mosler) to that Review.
And the Enquiry was flooded with special pleading like had not been aired in public before.
The Treasury’s (2002) own – Review Of The Commonwealth Government Securities Market, Discussion Paper claimed that purported CGS benefits include:
… assisting the pricing and referencing of financial products; facilitating management of financial risk; providing a long-term investment vehicle; assisting the implementation of monetary policy; providing a safe haven in times of financial instability; attracting foreign capital inflow; and promoting Australia as a global financial centre.
We heard some of that during the GFC – that the liquid and risk-free government bond market allowed many speculators to find a safe haven.
In other language – that the public bonds play a welfare role to the rich speculators.
The Sydney Futures Exchange Submission to the 2002 Enquiry considered these functions to be equivalent to public goods.
It was very interesting watching the nuances of the federal government at the time. On the one hand, it was caught up in its ideological obsession with “getting the debt monkey off our backs” – which was tantamount to destroying private wealth and the associated income streams and forcing the non-government sector to become increasingly indebted to maintain spending growth.
But it was also under pressure to maintain the corporate welfare. There was no public goods element to the offering of public debt. The argument from the financial institutions amounted to special pleading for sectional interests.
To understand all this we have to first establish what the legitimate responsibility of a currency-issuing government is in relation to the financial system.
Financial stability is a public good
The government is intrinsically responsible for maintaining financial stability.
The financial system is linked to the real economy via its credit provision role. Both households and business firms benefit from stable access to credit.
To achieve financial stability:
(a) the key financial institutions must be stable and engender confidence that they can meet their contractual obligations without interruption or external assistance.
(b) the key markets are stable and support transactions at prices that reflect fundamental forces.
There should be no major short-term fluctuations when there have been no change in fundamentals.
Financial stability requires levels of price movement volatility that do not cause widespread economic damage.
Prices can and should move to reflect changes in economic fundamentals.
Financial instability arises when asset prices significantly depart from levels dictated by economic fundamentals and damage the real sector.
Collapses brought on by injudicious speculation that do not affect the real sector or that can be insulated from the real sector by appropriate liquidity provisions are not problematic.
In general though, we want to build an institutional and regulative structure that insulates the real economy from financial collapses.
The essential requirements of a stable financial system are:
1. Clearly defined property rights;
2. Central bank oversight of the payments system;
3. Capital adequacy standards for financial institutions;
4. Bank depositor protection;
5. An institutional lender-of-last resort when private institutions refuse to lend to solvent borrowers in times of liquidity crisis;
6. An institution to ameliorate coordination failure among private investors/creditors;
7. The provision of exit strategies to insolvent institutions.
While some of these requirements can be provided by private institutions, all fall in the domain of government and its designated agents.
However, what is important for this two-part series, is that none of these requirements rely on the existence of a viable government bonds market.
Private goods are traded in markets where buyers and sellers exchange at prices that reflect the margin of their respective interests.
At the agreed price, ownership of the good or service transfers from the seller to the buyer.
A private good is ‘excludable’ (others cannot enjoy the consumption of it without being party to the transaction) and ‘rival’ (consuming the good or service specific to the transaction, denies other potential consumers its use).
Alternatively, a public good is non-excludable and non-rival in consumption. Private markets fail to provide socially optimal quantities of public goods because there is no private incentive to produce or to purchase them (the free rider problem).
To ensure socially optimal provision, public goods must be produced or arranged by collective action or by government.
Thus, financial system stability meets the definition of a public good and is the legitimate responsibility of government.
So then what are the alleged benefits of public debt issuance?
Most of the arguments made in favour of sustaining public debt issuance can be reduced to special pleading by an industry sector for public assistance in the form of risk-free government bonds for investors as well as opportunities for trading profits, commissions, management fees, and consulting service and research fees.
It is ironic that these arguments are inconsistent with rhetoric forthcoming from the same financial sector interests, in general, about the urgency for less government intervention, more privatisation, more general welfare cutbacks, and the deregulation of markets in general, including various utilities and labour markets.
Specifically, government price level intervention into private markets is typically challenged by economists on efficiency grounds.
Public debt issuance is a form of government price level intervention in interest rate markets.
The burden of proof falls on those arguing in favour of such issuance to show that the market in question is incapable of viable operation without government intervention and will, unassisted, produce outcomes detrimental to the macro priorities we discussed earlier – full employment etc.
Pricing other products
One argument mounted to support public debt issuance is that it supports the yield curve and is used by financial markets as the benchmark risk free asset, which provides a benchmark for pricing any other risky debt securities.
However, there are clearly alternatives:
1. The market could price securities against other securities with similar characteristics.
2. Market participants could price securities with respect to the interest rate swap curve.
Interest rate swaps have become a central part of the so-called ‘fixed income market’.
Pimco writes (Source):
An interest rate swap is an agreement between two parties to exchange one stream of interest payments for another, over a set period of time. Swaps are derivative contracts and trade over-the-counter.
A common arrangement has been to cast the ‘swap’ agreements relative to the London Inter-Bank Offered Rate or LIBOR, which is the interest rate that banks charge each other for short-term loans.
It is too complicated to go into detail here, but one party, which might be a corporation, swaps the uncertainty of a floating LIBOR for a fixed interest rate, hoping that rates do not rise. The counterparty hopes rates will rise which means the floating stream will be higher than anticipated when the contract was entered into.
The ‘swap curve’ shows the swap rates for all the maturities in which these arrangements are made and follows the government debt yield curve very closely, which is why I argue the ‘market’ already has a vehicle to use in pricing securities.
Market participants already use the interest rate swap curve to price securities. Regardless, the term interest rate structure remains a meeting of supply and demand. Buyers and sellers of bonds desire to attract each other and meet at a price.
Are the proponents of retaining public debt issuance really claiming that without government intervention in the credit markets via debt issuance borrowers and investors cannot sufficiently come together at a price?
Are they saying that the interest rate market does not have sufficient levels of participation, information and competition to adequately determine price without government intervention?
It is doubtful that either position can be substantiated, and certainly not to the degree needed to support the issuance of public debt with their high real macro costs which I will outline below.
Managing financial risk
Another argument is that on-going public debt issuance supports a number of derivative markets that help private traders manage financial risk, particularly in relation to interest rate risk.
What are their real interest rate risks of these businesses? What are the real economic costs of these feared changes?
Without going into detail, it is important to ask which businesses ‘need’ to use public debt to manage risk. The reality is that on-going public debt issuance supports and encourages speculation, rather than real investment behaviour.
Some financial market speculation (which is tied to helping real output producing firms off-load exchange rate risk, for example) is sound. But that is a tiny proportion of the financial market transactions that occur each day.
So can the support of particular businesses in this manner which add nothing to the well-being of the population be an appropriate use of public policy?
It is in this context that I use the term corporate welfare in association with the issuance of public debt.
It should also be understood that MMT advocates the simplification of financial markets and the phased elimination of speculative behaviour that provides no real benefits to the population.
Providing a long term investment vehicle
The crude argument is that workers have a right to expect their savings will be held in risk-free assets and that public debt issuance provides those assets.
It is a simplistic argument and while I am supportive of workers being able to save (risk manage their futures) in a safe way, that doesn’t justify the massive corporate welfare that accompanies the issuance of public debt.
More specifically, it is argued if superannuation and life companies were unable to purchase government debt then they would struggle to match their long-dated liabilities with appropriate returning assets.
Further, the claim is that eliminating the government bonds market would deny workers of a risk free asset to invest their savings in. Retirement planning would become highly uncertain and risky.
What is not often understood is that government bonds are in fact government annuities.
Do the proponents of on-going government bonds really want the private sector to have access to government annuities rather than be directing real investment via privately-issued corporate debt, as an example?
This point is also applicable to claims that government bonds facilitate portfolio diversification. Why would we want to provide government annuities to private profit-seeking investors?
This interferes with the investment function of markets. Direct government payments should be limited to the support of private sector agents when failures in private markets jeopardise real sector output (employment) and price stability.
We would also require a comparison of this method of retirement subsidy against more direct methods involving more generous public health and welfare provision and pension support.
But there is a much more effective way to provide a risk-free savings vehicle for workers. The government could create a National Savings Fund, fully guaranteed by the currency-issuing capacity of the government, which could provide competitive returns on savings lodged with the fund.
There would be no public debt issuance (and the associated corporate welfare and government debt management machinery) required.
The government could meet any nominal liabilities at any time.
Providing a safe haven
Government securities are alleged to provide a ‘safe haven’ for investors when there is financial instability.
The ‘flight to quality’ argument suggests that it is beneficial to the macro economy for investors to have a risk free domestic asset available to avoid capital losses on other assets.
However, in addition to the previous point regarding subsidy through government annuities, government bonds compete directly with these other assets, thereby driving down their prices and exacerbating matters during ‘flights to quality’.
In a monetary economy, investors can always hold money balances by increasing actual cash holdings or banking system deposits.
Widespread use of deposit insurance would mean that bank deposits would be equivalent to holding government bonds anyway for all practical purposes.
That also passes the ‘risk’ to private banks when they select their assets and selection of assets is regulated by the central bank.
There is no compelling real macroeconomic reason why risk and return decisions by private maximising agents should be ‘further protected’ by retreat to a market distorting government annuity.
Further, during a ‘flight to quality’ only the relative prices of various fixed income securities can change, not the quantity, as investors compete for the existing stock of outstanding government debt.
At the macro level, this process does not reduce risk.
Implementing monetary policy
So we are back to the starting point, where a lot of people think MMT justifies the issuance of public debt through appeal to the central bank’s desire to maintain an interest rate policy target through open market operations (selling debt to drain reserves).
However, as we have all learned since the GFC (but in Australia we already knew it before that), the central bank can maintain any interest rate target it chooses without any open market operations simply by providing a competitive support rate on excess reserves.
It requires no public debt in this regard.
So all the arguments that the central bank might need stocks of government bonds to sell or loan to commercial banks to stabilise interest rates, maintain liquidity, hit price stability targets are all spurious.
Some argue that the Basel requirements for capital adequacy require governments to provide the banks with risk-free bonds.
But again, the central bank can create risk-free, high-quality assets to sell to the commercial banks if it wants to increase the quality of the banks’ asset portfolio.
No government bond market is necessary to accomplish that.
So the reason governments issue debt is not to allow the central bank to maintain an interest-rate target.
There are many other arguments that are put forward to justify the ongoing issuance of public debt. All of them can be reduced to special pleading by speculators for risk free assets.
What are the real economic costs involved in issuing government debt?
The real economic costs involved in issuing government debt
The real costs of any resource-using activity are measured by the opportunity costs of not using these resources in alternative activities.
The operation of public debt markets absorb a diversity of real resources deployable elsewhere.
While this is difficult to assess in the context of an economy without public debt markets, some points can be made to structure our thinking.
The opportunity costs in terms of the labour employed directly and indirectly in the public debt ‘industry’ are both real and large.
The ‘cottage industry firms’ that characterise the public debt industry use resources for public debt issuance, trading, financial engineering, sales, management, systems technology, accounting, legal, and other related support functions.
These activities engage some of the brightest graduates from our educational system and the high salaries on offer lure them away from other areas such as scientific and social research, medicine, and engineering.
It could be argued that the national benefit would be better served if this labour was involved in these alternative activities.
Government support of what are essentially distributional (wealth shuffling) activities allows the public debt market to offer attractive salaries and distorts the allocation system.
While this labour may move within the finance sector if public debt issuance terminated, the Government could, for example, generate attractive opportunities by restoring its commitment to adequate funding levels for research in our educational institutions.
On balance, public debt markets appear to serve minor functions at best.
The public debt markets add less value to national prosperity than their opportunity costs. A proper cost-benefit analysis would conclude that the market should be terminated.
And finally, the motivation
In Part 1, we contrasted the requirements of government in terms of the Bretton Woods system and the modern, fiat currency systems.
The collapse of the Bretton Woods system in 1971 freed currency-issuing governments of any financial constraints, which meant that the previous rationale for issuing debt into the non-government sector to avoid compromising the central bank’s responsibility for defending an agreed currency parity no longer applied.
But the practice of debt-issuance continued.
Why?
Governments continue to impose voluntary constraints on themselves to satisfy the dominant ideological demands of the elites.
A little case study demonstrates how this played out in the post-fixed exchange rate world.
The Australian Office of Financial Management (AOFM) was set up as a special part of the Federal Treasury to management federal debt in the 1980s. The Australian experience is common around the world in almost all countries.
While there was a lot of hoopla about it being an “independent agency”, the reality is that this is all largely cosmetic – the AOFM is still part of the consolidated government.
Prior to the establishment of the AOFM, government bond issues were made using the ‘tap system’. The government would announce some face value and coupon rate at which it would issue debt and ‘turn the tap on hard enough’ to meet the demand at that yield.
Occasionally, given other rates of return in the financial markets the issue would not be fully subscribed – meaning some of the net spending would be covered. in an accounting sense. by central bank buying treasury bills (government lending to itself!).
In other words, the government could sell bonds directly to the central bank at whatever rate it deemed useful (including zero) and the private bond markets could do little about it.
This was common practice around the world.
This system was highly criticised by private bond markets and the neo-liberal cheer squads in economics departments.
In 2000, the Deputy Chief Executive Officer of AOFM (seemingly content on perpetuating neo-liberal myths) claimed the practice was:
… breaching what is today regarded as a central tenet of government financing – that the government fully fund itself in the market. It then became the central bank’s task to operate in the market to offset the obvious inflationary consequences of this form of financing, muddying the waters between monetary policy and debt management operations.
The so-called “central tenet” – is pure ideology and has no foundation in any economic theory. It is a political statement.
In the face of massive pressure from the neo-liberal lobbies, the Australian government at the time it established the AOFM also changed the way the Australian government bond market operated.
They replaced the tap system with an auction model to eliminate the alleged possibility of a ‘funding shortfall’.
Accordingly, the system now ensures that that all net government spending is matched $-for-$ by borrowing from the private market. So net spending appeared to be ‘fully funded’ (in the erroneous neo-liberal terminology) by the market.
The central bank wasn’t prohibited by law from purchasing government debt (directly) for ‘liquidity management’ purposes but the change meant that the price (yield) would vary to accommodate even the most risk-averse private bond dealer and so the volumes would always be sold.
But in fact, all that was happening was that the Government was coincidently draining the same amount from reserves as it was adding to the banks each day via the fiscal deficit and swapping cash in reserves for government paper.
The auction model merely supplied the required volume of government paper at whatever price was bid in the market. So there was never any shortfall of bids because obviously the auction would drive the price (returns) up so that the desired holdings of bonds by the private sector increased accordingly.
As an aside, at that point the secondary bond market started to boom because institutions now saw they could create derivatives from these assets etc. The slippery slope was beginning to be built.
But you see the ideology behind the decision by examining the documentation of the day.
Around the time these changes were introduced, the Deputy Chief Executive Officer of AOFM gave a speech.
He spoke of so-called captive arrangements, where financial institutions were required under prudential regulations to hold certain proportions of their reserves in the form of government bonds as a liquidity haven.
… the arrangements also ensured a continued demand from growing financial institutions for government securities and doubtless assisted the authorities to issue government bonds at lower interest rates than would otherwise have been the case … Because such arrangements provide governments with the scope to raise funds comparatively cheaply, an important fiscal discipline is removed and governments may be encouraged to be less careful in their spending decisions.
So you see the ideological slant.
They wanted to change the system to voluntary limit what the Federal government could do in terms of fiscal policy. This was the period in which full employment was abandoned and the national government started to divest itself of its responsibilities to regulate and stimulate economic activity.
And in case you aren’t convinced, here is more from AOFM:
The reduced fiscal discipline associated with a government having a capacity to raise cheap funds from the central bank, the likely inflationary consequences of this form of ‘official sector’ funding … It is with good reason that it is now widely accepted that sound financial management requires that the two activities are kept separate.
Reduced fiscal discipline … that was the driving force.
They knew that the public didn’t have a clue about any of this but had been conditioned to associated rising public debt with all manner of bad things – overspending, mismanagement, intergenerational harm (burdening the grandkids), risk of going broke, and all the rest of it.
They knew that if they forced governments to issue debt to match deficits, through these institutional arrangements, which they knew were unnecessary for the reasons that the public were led to believe (funding governments), then the public could be politically manipulated to reject progressive policies.
They were aiming to wind back the government and so they wanted to impose as many voluntary constraints on its operations as they could think off.
All basically unnecessary (because there is no financing requirement), many largely cosmetic (the creation of the AOFM) and all easily able to be sold to us suckers by neo-liberal spin doctors as reflecting … read it again … “sound financial management”.
What this allowed was the relentless campaign by conservatives, still being fought, against the legitimate and responsible use of fiscal deficits.
Conclusion
Part of this post was drawn from an edited version of a submission that I made with Warren Mosler in 2001 to the Commonwealth Debt Inquiry, which sought to justify why the government should continue to issue debt when it was in fact running increasing surpluses.
Yes, Warren and I and others have been at this for a very long time!
Other references:
1. There is no need to issue public debt (September 3, 2015).
2. Direct central bank purchases of government debt (October 2, 2014).
3. Market participants need public debt (June 23, 2010).
That is enough for today!
(c) Copyright 2020 William Mitchell. All Rights Reserved.
“What is not often understood is that government bonds are in fact government annuities.”
Tradeable government annuities as well.
It’s the tradability that doesn’t appear justified. You can’t usually sell your retirement pension for a cash lump sum once you are retired – for what should be obvious reasons.
I’ve never seen any justification for the tradeability, or any real reason why there is a pension fund intermediary in the way. Why not simply take the pension lump sum and buy a government annuity with it that is paid directly.
Which would then look remarkably like a state pension but with a regressive profile (richer people who were able to save more will have bigger state pensions than poorer people).
“They wanted to change the system to voluntary limit what the Federal government”
The other way of looking at it is the move from the elected to the unelected. Rather than the legislature determining what government can and can’t spend, these characters believe a cabal of Insurance Funds, banks, and other assorted financial types should determine what government can spend.
And apparently that is better for us than hospitals with capacity to cope with a national emergency.
Thank you Bill for both those articles. I love history. It always explains the ‘now’.
One thing I find interesting is why are Russia and China hoarding gold? I can see how China would like to see a digital currency to replace the US$ – a bit like Keynes’ Bancor but to tie it to gold does not make any sense to me.
Dear Bill, many thanks for this eye opening article. Could you please make available the paper you and Mosler submitted in 2002? The link you give in your 2010 post is no longer valid… Thanks!
just thinking on the opportunity cost perspective – I would think the ability to buy government bonds say, in a crisis, would possibly make it harder for business to attract investment.
My thought was that if someone has $X to invest, they might choose a government bond over investing in something else, such as a business. In a crisis people become risk averse and government bonds allow people and businesses to get a return without taking a risk.
Also on Neil Wilson’s note regarding tradability – isn’t this really just an efficiency argument? If you weren’t allowed to trade bonds, then you would have other financial instruments. Ie person A bought a 1 year bond for $95 with face value $100 today. Suppose it is 6 months later and person A wants their money now instead of waiting 6 months. If they can’t sell the bond, then they could enter a bond like contract with person B. Person B lends person A $Y now and will be paid $100 by person A on maturity of person A’s 1 year gov bond with $100 face value (I suppose you could call this a 6 month “person A” bond with fv $100). The value $Y is the equivalent to the “secondary market” bond price when bonds are tradable. The cash flow is the same as if bonds were tradable. But there is less administrative complexity of the arrangement, particularly once you increase the number of times a bond is traded. For example if it was traded 26 times, under a non-tradability “workaround” this is 26 contracts that all mature at the same time…Ie gov gives person A $100 who then gives $100 to person B who then gives $100 to person C and so on until person Y gives $100 the they got from person X over to person Z. This is the same net effect as if gov gives person Z $100.
V long post.
I didn’t follow the “Interest rate swaps have become a central part of the so-called ‘fixed income market'” point. They have, but I don’t think they can price the credit risk of government debt.
Well I suppose they can, via traded CDS spread, but then if you purchase insurance on government bond risk from a counterparty, say Goldman Sachs, then you have counterparty risk with Goldmans.
“What is not often understood is that government bonds are in fact government annuities.”
No, an annuity is a contract to pay the annuitant for rest of life under certain terms (usually a flat nominal amount, or inflation linked). The annuity disappears when you pop off, Government bonds you can keep after you are dead.
The longevity weighting gives the annuity an uplift over gilts.
Annuities are only possible when there is a large enough pool of annuitants to manage the lumpy cashflows.
There is no reason the gov can’t issue annuities, indeed there is the state pension, but you can’t buy one from the gov.
Hi Bill
I may have misunderstood, but am not clear on the following para:
“It is too complicated to go into detail here, but one party, which might be a corporation, swaps the uncertainty of a floating LIBOR for a fixed interest rate, hoping that rates do not rise. The counterparty hopes rates will rise which means the floating stream will be higher than anticipated when the contract was entered into.”
Has the corporation already borrowed on a floating rate and wishes to hedge by through a swap by paying fixed and receiving floating? In which case the counterparty will hope for an interest rate fall and the corporation will be indifferent to rate changes, which is the point of the hedge.
Or is the corporation looking to speculate on rates falling, in which case they want the uncertainty of paying floating and receiving fixed? In which case the counterpary will hope for an interest rate rise.
Cheers David
I was waiting for Bill to make this crucial point as I read through his post…and he finally did. “They knew that the public didn’t have a clue about any of this but had been conditioned to associated rising public debt with all manner of bad things – overspending, mismanagement, intergenerational harm (burdening the grandkids), risk of going broke, and all the rest of it. They knew that if they forced governments to issue debt to match deficits, through these institutional arrangements, which they knew were unnecessary for the reasons that the public were led to believe (funding governments), then the public could be politically manipulated to reject progressive policies.” I would submit that the PRINCIPAL purpose of issuing federal bonds is to create the false appearance that even federal fiat money created by federal spending decisions is and must be linked to debt. Although federal taxes also serve the important purpose of valorizing official currency, both taxes and bonds are tools of obfuscation of the most radical truth revealed by MMT: that modern money is purely fiat money, able to be created and invested however the government sees fit, with the only constraint (to avoid inflation) being the availability of existing resources to invest in. It’s a waste of time to try to reason with a con artist, as Bill admirably attempts to do in much of this post and, it seems, in his work in general. The only way to deal with a crook is to reveal his or her ruse. This is precisely what MMT does so well and thus explains why it is so hated by neoliberalism, crooked to the core.
“This is precisely what MMT does so well and thus explains why it is so hated by neoliberalism”
In both its New Keynesian and Monetarist garbs.
When you see the term “independent”, read “unelected” and you won’t go far wrong.
They’ve got great PR these neo-liberals.
Re Patricia Smith:
The Russians and Chinese, and no doubt others, are reacting to the United States using its control of the international monetary system as a weapon. It has excluded countries from SWIFT, the international currency clearing mechanism, making international trade difficult. The US has also held enemy countries’ foreign currency deposits hostage. No doubt there are other attack mechanisms that don’t don’t come to mind at the moment. So the problem, especially for an enemy country with a trade surplus, is how to protect its foreign currency holdings. All the alternative reserve currency countries are US vassal states (EU, Japan, UK, Switzerland, Canada, Australia) and will fall in line with US dictates. The only realistic option is to buy gold. Of course they could buy real assets but they are largely excluded from these markets in the developed countries where most of the opportunities lie.
Bill, I just finished an old book whose conclusion made me think of you and MMT.
The book’s called A History of Economic Thought by William J Barber (1967). It’s divided into four sections: Classical Economics (Smith, Malthus, Ricardo, Mill), Marxian Economics (Marx), Neo-Classical Economics (Marshall, Variations – Walras, Clark, Bohm-Bawerk, Wicksell) and Keynesian Economics (Keynes).
In a brief epilogue, the writer says, “It is important to recall that the pioneers in each of these traditions shared a distinguished attribute. All of them took up their pens in a mood critical of established institutions or patterns of thought. If some of their doctrines were later appropriated to justify the status quo, such complacency was alien to the innovators. It was this grand tradition that Keynes had in mind when he once described economics as a ‘dangerous science’.
Bill,
Interesting post. There is a point you do not mention in this explanation.
If no bonds are issued to drain excess reserves from the interbank system, the accumulated fiscal deficits will eventually grow to a very large number there. The commercial banks will collectively wind up holding those excess reserves (called “excess settlement balances” in Canada) and will have no way to remove them and exchange them for more profitable assets. Granted a small return in the form of interest on reserves (or on “settlement balances”) may be paid but presumably the commercial banks will have more profitable outlets than that. The low return for the banks on such a large volume of assets will lower their profitability, something they will not like. They might try to compensate with higher fees or higher interest rates on mortgages.
In a country such as Canada where the commercial banks are very powerful there would be very strong pushback. The crux of my point is that this aspect is not ideological, it is a matter of profitability for the single most powerful business entity in the country. Indeed, other technical aspects of the MMT program are also associated with challenging political realities.
I read the 2 parts – which is no simple deed – but I must confess I don’t think I’m able to answer the question “Why do currency-issuing governments issue debt?”
Would this be the answer?
“[Because] Governments continue to impose voluntary constraints on themselves to satisfy the dominant ideological demands of the elites.”
I confess I’m a little lost there and would be grateful if anyone could help
Intro –
“However, there are many justifications for continuing to issue debt that circulate. In this Part, I consider those justifications and conclude that the on-going practice of government’s issuing debt to the non-government sector is primarily an exercise in corporate welfare and should not be part of a progressive policy set.”
Isn’t there another issue with “public Debt” supposedly matching the fiscal deficit? The government already resolved the debts in the deficit when it created the money supply by buying off the debts that were authorised by the government’s fiscal forecasts…So the national debt had already become redundant. The FIRE sector just gets a return of interest for free as well.
I saw that Philip Lowe came out agreeing that money is from thin air. I cannot recall where but he cautions being careful about it.
Andre – You’ve hit the nail on the head, really.
Keith Newman:
Tax them and create a public bank that drives them out of business.
@ André
Yes, the decision by the monetary sovereign to issue debt is a political one in favour of “the top end of town” as Bill styles it, or the oligarchs in my lexicon.
It’s not an economic necessity, as the propagandists would have us believe; it’s a political choice.
Last night I listened to a podcast by Al Frankin, with the guest Paul Krugman.
“Paul Krugman on Arguing with Republican Zombies (May 24, 2020)
73,160 views”
Apparently he has a new book about Zombies. Here he means Zombie ideas that Repuds hold or at least use to justify their actions. They are zombies because you can’t seem to kill them. Examples are — deficits *do* matter, tax cuts pay for themselves, etc.
Paul seemed open to a lot of MMT’s ideas now. He said that a UBI can’t be afforded (it might cost $5T/yr) so therefore it would be better to just help the unemployed and other people who need help. So, he doesn’t mention our JGP. He was talking about the post crisis economy so he must intent for “unemployment” to include people who are not looking for work, because there are no jobs because of 2 things, a] automation and b] lingering effects of the covid-crisis.
. . .But, he did make more sense than he has been before.
He and Al agreed that the Filibuster rule in the Senate must go if the Dems take the Pres., House, and Senate. Which idea with the conditional (if we take P, H, & S) I’ve been pushing for many years now, because we need to undo a lot of bad Repud stuff and we can’t if the Repuds can use the filibuster to block us. They talked about making old “norms” into actual laws (Pres. candidates must release their US tax returns, the Justice Dept. must be more independent, etc, etc.).
“The crux of my point is that this aspect is not ideological, it is a matter of profitability for the single most powerful business entity in the country.”
(i) There isn’t anything more profitable to do with the money – because that’s not how banks work. Remember that Bank Reserves and Government Bonds are essentially “forced loans” to the government sector at an interest rate determined by the government sector. In return the Banks hold insured deposits that match those loans. Those deposits are savings in the currency of issue. Since they are all excluded from all banking ratios, because these loans can never have any call on the bad loan buffer of equity, that have no impact on the underlying profitability of banks.
(ii) Exactly why are banks “powerful”? Because they currently are the mechanism for injection of money into an economy. Hence why pushing loans has been such a big part of the Covid economic response. Remove that role and you can let banks go bust daily if you want to. That eliminates their power.
Banks should get no reward for holding deposits. That’s the deal for having access to a lender of last resort. If they don’t like that, then you remove the lender of last resort function from them which forces them to put their interest rate up, and puts them out of business against those with a lender of last resort function.
Yes, I understand all that Keith but the gold isn’t being used for jewellery. To tie their money to gold doesn’t make sense when gold is not connected to any currency in the world. However our view of ‘making sense’ is a western view. The Chinese look at things differently. I have wondered if they use all their American gilts to build the one belt one road. Now that would make sense.
“To tie their money to gold doesn’t make sense when gold is not connected to any currency in the world.”
It only makes sense if you believe you need something “hard” on the asset side of a bank’s balance sheet before you can issue the “discount” (ie the liaiblities).
Remember, at heart, bankers are just pawnbrokers in shinier suits.
I find it endlessly amusing that banks issue derivatives over all sorts of underlying assets knowing full well that the majority of those contracts will never deliver the underlying. But they struggle to get their head around the idea that a currency is just a derivative of the power to tax.
@ Neil Wilson
“Exactly why are banks ‘powerful’? Because they currently are the mechanism for injection of money into an economy. Hence why pushing loans has been such a big part of the Covid economic response. Remove that role and you can let banks go bust daily if you want to. That eliminates their power”.
That seems to me to chime exactly (I say again) with the part of Positive Money’s approach with which – for exactly the same reason as you are citing here (“Remove that role and you can let banks go bust daily if you want to”) – I’ve always agreed, whilst discarding much of the rest.
The PM approach as I’m sure you know aimed first and foremost at achieving exactly the same aim as you are defining here (and as the ‘thirties Chicago Plan was aimed-at), namely to stop private banks from being a source of the economy’s money-supply through the medium of making loans/creating deposits out of thin air. Private banks would then be confined strictly to operating the “loanable funds” model of banking – ie as financial intermediaries/maturity-transformers. Most vitally of all, they would be prohibited from taking customers’ “demand deposits” onto their own balance-sheets.
Is that what you mean by the above-quoted passage? If not, what am I misunderstanding? I stress that I really do want to make sure I’ve correctly understood your position (not least because I have a healthy respect for your insight, as an exponent of MMT thinking).
“Private banks would then be confined strictly to operating the “loanable funds” model of banking”
What they propose has zero control function. It’s just a rearranging of the deckchairs. In control terms it is nothing more than a change from an insured system to an in specie system.
There is no need to change anything. All you need to do is remove the restriction on government spending.
PM’s approach boils down to “put the interest rate up on loans”, and that’s it. We can do that with the existing structure if we want to.
They just don’t seem to understand the dynamics of how banks work. There is never any call from the Loan department to the Treasury department in a bank that says “have we any money left”. It never happens and never can happen if a bank is to operate effectively. Most loans take weeks to process. Uninsured liabilities can be issued and sold in minutes. The Treasury department always knows how much money they need well before they need it. It’s standard loan sales pipeline stuff.
UK Building Societies worked out how to front run an effective loan book one step away from the clearing system decades ago. That’s how Halifax became the world’s biggest building society despite being supposedly limited by “Paid Up Shares” accounts. I was fortunate enough to get that first hand from the Greybeards that wrote the system – after they stopped laughing when I asked them where they kept the money.
Posted a short comment – to a piece in The London Economic expressing unspoken horror that government borrowing has hit a new record high – with links to the above part 2 and part 1 of Bill’s very excellent informative and hopefully easy to understand historical context of the MMT lens : Thanks Bill ! ….
https://www.thelondoneconomic.com/business-economics/economics/government-borrowing-record-62bn-in-april-to-cope-with-coronavirus/22/05/#comment-199682
“Ask a silly question…”
(I should have known better).
“the necessity to issue public debt disappeared as fixed exchange rates and convertibility was abandoned in the early 1970s”
Issuing public bonds to match public appropriations, once it started, was always a policy, not a natural law. And the last episode of fiat currency started in the 1920s/1930s, and only made a faux reappearance w the 1944 Breton Woods Agreements. Why on Earth do so many say fiat currency operations commenced only in 1970? That merely marked the final year of INTER-GOV gold-convertibility, not limits on fiat currency appropriations. It’s a distracting and irrelevant argument, just when it’s of paramount importance to arrive at the fundamentals of fiat currency operations.
Please, just cease, forever, the fixation on 1970.
“…the central bank can maintain any interest rate target it chooses without any open market operations simply by providing a competitive support rate on excess reserves.”
What exactly would be competitive support rate on excess reserves?
Rafael, I think it means that the central bank, if it desires to maintain a positive floor interest rate target, offers interest on the excess reserves close to that desired positive floor rate. Banks won’t usually lend at interest rates below the floor rate the central bank is paying. It is one way for the central bank to hit its target interest rate- pay banks not to lend below that rate. I should have been a banker…
roger erickson:
Right. For the USA 1933 is the important date; there was no constraint after that. For the rest of the world, Bretton Woods had some meaning, probably not as much as usually ascribed.
But just as the formal, self-imposed restrictions vanished, there was massive successful propaganda that they existed and were binding – and governments worldwide behaved as if they did, far more than during Bretton Woods!
It is as if a prisoner who had been trying to escape for years – was finally released. And then huddled in a corner in his jail cell in terror.
Several people: “Because they [private banks] currently are the mechanism for injection of money into an economy. ”
“The” mechanism is incorrect. “A” mechanism is correct, is what MMT – and accounting – insists on – that governments inject money too.
Since there are many cranks -even organizations – out there who insist on the impossible idea that governments get government money from the banks rather than vice versa, I think one should never give them an opening.
government can pay interest on reserves and doesnt need to sell bonds, ok. but, for example, Brazil, where access to credit is hard and interest is high, paying more interest on reserve wouldn’t make banks even more reluctant to lend?
“paying more interest on reserve wouldn’t make banks even more reluctant to lend?”
In theory, as I understand it, private banks will never turn down profitable business. If a borrower comes along who looks capable of repaying the loan and the interest, a bank will issue the loan. Private banks manage their reserves in a separate system. In the interbank credit market, a bank running low on reserves will borrow from banks with excess reserves, effectively splitting the profit from the commercial/consumer loans they made. If the Central Bank pays a uniform interest rate on all reserves, then the actors in the interbank market wouldn’t care what it was .. the interbank lender would want a higher rate from the interbank borrower, but the interbank borrower would have interest on their new reserves to offset the higher interbank interest they had to pay.
Interest on *excess* reserves would break that symmetry, and maybe carry through to higher commercial/consumer interest rates, and maybe dissuade businesses and consumers from borrowing.
That’s in theory, as I understand it. If there are arrangements in the Brazilian banking system that contradict this (my) theory, it would be interesting to know.
Re: “government can pay interest on reserves and doesn’t need to sell bonds, ok. But, for example, Brazil, where access to credit is hard and interest is high, paying more interest on reserve wouldn’t make banks even more reluctant to lend?”
Dear Rafael,
I think your question (and observations) reflects some problems in the economic system of Brazil (if she uses fiat currency).
I don’t know anything about Brazil economy, but fiat currency. So, let me try to answer it from the MMT’s perspective, in particular with reference to Bill’s latest answers to the Quiz no. 2-3 (See Weekend quiz, June 20-21, 2020).
First of all, as Bill said, loans create reserves, thus, lending does not depends on reserves.
In relation to that, lack of reserves cannot usually occur because central bank has to supply whatever the overnight reserves clearing system needs. Otherwise, the overnight interest rate will go up, which the central bank doesn’t really want this (unless they are caught sleeping on the job, like what happened in the US, recently).
Thus, the central bank will have to supply whatever the desired amount of reserves needed at the ‘going rate’ (the overnight target interest rate, for example, 0.5% in the US at the moment).
Otherwise, the central bank cannot control the overnight interest rate, which means the financial system can come to a halt due to lack of liquidity (and/or overnight interest rate can hit the roof like what happened in the US one night, a few months ago).
Just to be clear, the two things cannot happen at the same time. Meaning, you cannot control the interest rate and control the amount of reserves at the same time.
(Imagine a market where you try to control the ‘price’ of oil and the ‘amount’ of the oil availability at the same time.
You will learn that something different will happen.
So, coming back to your question, something else has to be at play in the Brazil’s economy when you said ‘credit is hard to access and interest rate is high’.
For example, high interest rate maybe the result of central bank policy due to large foreign debts, which reflects the credit risk of Brazil.
There are other explanations of course, like, high household debts, lack of credit worthy borrowers, poor economy, fear of inflation, fear of economy overheating, incompetent central bank, incompetent government like insufficient money supply (low deficit spending) and so on.
In sum, paying interest on reserve is not really matter, nor it can push bank lending rate up, thus, it will not cause the banks to become reluctant to lend.
Something else is at play.
Meaning, something unusual is going on, or maybe that you just frame the problem from the money multiplier view of credit creation, which never really exists.
Have a nice Sunday!
Vorapot
Brasil has it own money, the Real and it has the second biggest bank spread. maybe the reason why banks has interest so high is poor economy, lack of credit worthy borrowers.
People here accuse MMT to fit just the reality of developed nations, underdeveloped nations like Brasil, that depends on dolar, has no real sovereignty.
“if the debt to GDP ratio continuously grew, and interest payments on the debt grew faster than national income, while affordability cannot be an issue, the crowding out of other types of important government spending would be a concern.”
I think this sentence from Macroeconomics book of Mitchell and Wray explain the situation of developing nations. MMT should write more about their reality.
I would like to know more about this: do public debt in developing nations has a different purpose than in a country with zero or near zero rate? government bonds are used to parasitize national income?
Re: “do public debt in developing nations has a different purpose than in a country with zero or near zero rate? government bonds are used to parasitize national income?”
Dear Rafael,
I will explain/answer things about developing countries and your questions in relation to MMT using my country situation, as an example.
Thailand has very low interest rate (0.5%), roughly 43% public debt to GDP, little foreign debts, moderate current account surplus, low inflation (1%), high household debt to GDP (97%).
Our average income is about 6,000 US dollars per person/year, strong currency (Baht), quite high foreign reserve and etc. Well, you get the pictures.
It sounds good, however, only 1% own 80% of the wealth, and the other 20% is being shared among 67 million people.
Meaning, mass low income workers (11 dollars per day).
Anyway, recently the government has just passed 1.9 trillion bahts to help people weather the pandemic.
Nothing happens, our currency is still strong, our foreign reserve still grows bigger by the day.
This is happening even when our jobless numbers might grow from 300,000 to 4 millions in 3 months.
So, i think I answered your first question, the purpose of public debt is the same, regardless of high or low interest rate, but more related to MMT predictions.
Our main problem, I think, lies in that fact, like many others, that the national wealth is concentrated among the 1%.
The yearly government budget seems to ensure that it remain so (we spend 80% mainly on paying government’s people salary, and 20% for investment).
Further, most prominent economists here believe bond selling produces crowding out effect.
But, as you can see, this is not really happening (if we judge from the fact that we just spend 1.9 trillions, the interest rate still remains low, currency remains strong, inflation become even lower)
Here, I would like to mention that Steve_American (one of the readers on this blog) once even made an interesting observation (few months ago) that 1 US dollar here goes 5 times further than in the US (he must be on the moon retiring here).
(1 US dollar can get you a nice healthy delicious lunch with a glass of water throw in also – almost every where in Thailand even in Bangkok).
In short, I think our problem is insufficient public spending for the good of the country (the majority of the people).
Lastly, I believe, our problems can be easily solved like Bill has explained via MMT lens many times.
But that is not going to happen.
You know the reason why, looking at all the debates, comments, ideas sharing and etc., on Bill’s blog.
I hope this adds to our discussions.
Best regards,
vorapot