Archive for February, 2011

Two Minutes Hate: Why not accept the Basic Accounting of MMT?

February 22, 2011 10 comments

From the Comments:

Given that, I still cannot understand why it is so hard for people to grok the sectoral balances accounting identity
G-T = S-I + M-X
which makes it clear that for a country with CAD (M-X>0) such as ours government deficit G-T is absolutely necessary for domestic private sector’s surplus S-I. I did not study economics but I had the impression that this equation is taught in every elementary economics course. What is then the objection people might have to this simple fact? What am I missing?

If you look to why people don’t like MMT, Austrians are the leaders of the two minutes hate.  People like Bob Murphy hate the fact that money is and always has been a construct of the state.

Murphy mistakes assets for savings, and he doesn’t understand the fundamental powers of government. I’ll give him a very, very slight break – Austrians confuse the real and monetary economy as a badge of honor.  See the discussion of 1 for more details.

Discussion of Murphy’s mistakes: Murphy makes two fundamental mistakes.  The first mistake results from his confusion of assets and savings. Murphy doesn’t understand the meaning of the word savings in an national accounting sense, or deliberately confuses real and monetary accountings.

Wynne Godley's Matrix of Accounts

The word savings in national income accounting has a very specific meaning, and stock ownership isn’t part of the definition. Stock ownership isn’t part of the definition because of a simple reason – any transaction involving stock simply transfers money from one person to another person, and doesn’t create any money at all.  The amount of money in the system remains the same.

The goal of monetary accounting is to identify where the money is.  It is not to value investments and assets.

Really, he makes two different errors related to this identity, but I’ll roll them up into misunderstanding of the word savings.   (Aside: Wynne Godley does a better job with the accounts in his work and is must read  to further your understanding money.)

Murphy’s confusion of savings and assets can be demonstrated easily.  To have savings in a monetary economy, you must have those savings in money.  Owning and asset worth money is not savings, even though it may be a valuable asset that you could exchange for money.  In national income accounting, we count the money, not the valuable assets.  The total net worth of the United States is roughly $55 Trillion, nobody in their right minds would say we have $55 Trillion of savings, simply because worth and savings are two very different ideas.

His example of a bus driver buying stock is a perfect example of this error.  The bus driver has decreased his savings of $1000 to purchase an asset for $1000.  Somebody else now has the $1000 cash money and the bus driver has some stock that someone else owned, so the savings across the economy are the same.

Nowhere in any national accounting does this transaction make any difference – because the amount of cash and stock in the economy does not change.  There is still $1000 in cash out in the real world.

For any given currency, savings only matters across the entire economy. Yes, my personal savings matters to me. But if I hold my savings, and somebody else has a deficit that exactly equals my savings, overall, there is no savings in the economy.

Re Murphy’s second mistake:  Governments are different than all other entites.  Here is a quote:

But perhaps a clearer way to pinpoint the fallacy in Nugent’s argument is to tweak it ever so slightly. Note that there is nothing special in choosing the US federal government as the financial entity in question. Nugent could just as easily have argued, “The Murphy household deficit = non-Murphy-household savings (of net financial assets).” Then, if the data indicate that right now the Murphy household spends $10,000 more annually than it earns in income, while my wife’s Colombian relatives lend us $10,000 net this year, then US (government and private) net savings (vis-à-vis my household, that is) must be zero. Clearly I need to go buy some more Big Macs and plasma screen TVs lest the nation’s children find it literally impossible to put money in their piggy banks.

He is right – on an accounting level, there is no difference between people and governments.  The accounts are treated the same – debits and credits are debits and credits.

On a practical level, there is a massive difference. Governments have a monopoly on the legitimate use of force within a geographical area.  Murphy understands this as he demonstrates in his next section.  What he fails to understand is that as far as I know, the advance of civilization has been always and everywhere accompanied by  government and government issued money.  There is one non-contacted tribe in the Amazon who doesn’t pay any taxes, and Mr. Murphy is free to live where he chooses – so he could go live with them and not pay taxes on his earnings. But everyplace else on the globe requires the payment of taxes.

It seems like a universal law of human behavior – Humans use speech, use tools, create government, collect taxes.  Didn’t Ben Franklin have something to say about Death and Taxes?

In many ways, the story of civilization is the story of advances in government.  For example, there is an entire sub-discipline of economic history devoted to the investigation of why former English colonies have performed so much better than French colonies.

It appears that when the hand of government is light, modern weaponry allows brutal monsters to take control of the population with ease. See Northern Mexico for what happens when government abdicates responsibility within a region.

Do Austrians like the idea of Freedom, but hate actual Freedom?

Murphy is disgusted by this idea that people like government and are willing to pay for it.  In fact, a leading light of the “libertarian” movement, Peter Thiel has come to a similar conclusion.  Thiel says: “I no longer believe that freedom and democracy are compatible.”  Wow.  He must want a dictatorship where his ideas of freedom are enforced at gunpoint.

One of the more odd things about the Austrian arguments is that in many ways, MMT provides them with a huge tool set to do real research, but because they hate empirical study so much, they won’t bother.  Check out this quote from Murphy:

The standard Misesian/Hayekian explanation of the business cycle is that the commercial banks arbitrarily increase the supply of loanable funds, even though the community hasn’t actually increased its real savings.

That isn’t far from the MMT/Minksy view in some ways.  MMTers also say that banks are not constrained by deposits, and Minsky’s instability hypothesis is that banks increase lending (and go through his 4 levels of financing) due to competitive pressures until small, unexpected shocks make formerly profitable loans massively unprofitable. We’ve just done the accounting to show this is the case, instead of stating it as a truism.

There is another class of 2 minutes haters, and these are people who understand the math and accounting, but wave their hands because they don’t like the conclusions.  This includes people like Jessie over at Cafe American, and a few other people. They either mock the math as being defined as true and therefore meaningless, when nothing can be farther from the truth. As .  or simply don’t like the fact that you can actually do hard work and figure out with math something they’ve spent a lifetime talking about with mushy words.  I’ll have more on Jessie Thursday.

Are Investors Paying the U.S. 8% for the privilege of owning U.S. Debt? Zero Hedge and The Daily Capitalist think they are!

February 16, 2011 10 comments

I like to read both Zero Hedge and The Daily Capitalist.  I find Zerohedge perfectly amusing, but I actually get something out of The Daily Capitalist.

John Williams: The easiest way for the U.S. Government to get out of debt is to issue more debt.

But then, the Daily Capitalist quoted Shadow Stats – saying that inflation might be closer to 8% than 1%.  Fortunately, we have some market indication about what inflation might be.  The equation for Treasury rates is generally given as

Treasury Rates = Inflation Rate + Real Rate of Return


Real Rate of Return = Treasury Rate – Inflation Rate

The real rate of return is important, because this is how much money you make after you take inflation into account.  If you make a total return of 3% a year, but the inflation rate is 100% a year, you’re losing your ass in that investment, because you need 100% a year just to retain your purchasing power.

We know the yield for any maturity in the U.S. Treasury Market.  We have numbers from yesterday for the entire yield curve – the market for U.S. Treasuries is one of the most liquid in the world.  Let’s plug in the 6 month Treasury Rate and the Shadow Stats “8% inflation” number into see how much real return investors in U.S. Treasuries are getting.

RR of R = .16% – 8% = -7.84%

-7.84% Real Return.  A negative real return!!  These investors are losing truckloads of money in real terms!  That means that investors are so desperate for Treasuries, they are willing to pay nearly 8% to lend money to the U.S. government for 6 months.  Do you believe investors are paying money to hold U.S. debt?  I do not.

If Shadow Stats is correct, issuing debt is a money making operation for the U.S. government.  If these investors are getting a -7.84% return, that means the U.S. government is making 7.84% on every dollar it lends! That’s a solid return.

Clearly, the best way for the U.S. to get out of debt would be to lend as much money as possible right now – because they are making 8% a year on just lending money!

Of course, this isn’t the case.  The U.S. government is not getting paid to lend money, and it is not making 8% on every Dollar it borrows.

I pointed this out a few days ago, but it bears repeating.  Shadow Stats is very, very, very wrong about inflation.

Was the bond selloff entirely due to Pimco selling at least $100bn of Treasuries??

February 16, 2011 1 comment

Bill Gross runs the largest bond funds in the world.  His flagship fund has $250bn of bonds in the fund.  In September, 51% of the fund was in Treasuries.  By the end of December, only 22% of the fund was in bonds. Today, only 12% of the fund is in bonds.

This is a sale of about $100bn in bonds over that time.  In the first three months, the fund sold about $75bn of bonds.  This is a gigantic flow of bonds by any measure.

But this $250bn fund is only a fraction of the entire Pimco fixed income allocation. Pimco manages over $1,300bn as of the end of 2010.  Pimco says the “bulk” of the money is devoted to fixed income investing.  “Bulk” to me means 80% or more – which given $1.3tn in total funds, would be 1,040bn allocated to fixed income investing.   Wow.

We don’t know the entire amount of Treasuries that Pimco sold in total, but if they sold in their other funds with the same intensity, Pimco divested their funds of at least $200bn in Treasuries, and perhaps as much as $400bn!   That is as much as 2/3rds of the size of QEII!  And much of this selling had to happen before the buying in QEII even began.

We do not know when Gross started selling bonds. Nor do we know if any of his other bond funds also sold treasuries.   But we do know there are no other $1.3 Trillion funds who are willing and able to dramatically change their allocations over the course of  a few weeks.

Can you find the runaway spending during the crisis? How about the Surplus of the late 1990′s?

February 16, 2011 Leave a comment

A good way to highlight recessions is to make the area of the recession Gray.

This graph has been mentioned a few different places.  The idea is that government spending didn’t really accelerate during the crisis – in fact, you can barely tell any difference at all in the total amount of spending.  But I don’t like this graph for a few reasons.  First, it has a 10 year time line, which is too short to tell if the trend is really solid.  Then, it has called attention to your eye by using the recession bars.  Also, it uses raw numbers, and not log numbers.  Log numbers are appropriate for dealing with things that grown exponentially, like economies.

Clearly, this chart could be improved with a few simple changes. It would show what actually happened better, and in a way that makes it totally clear that the government hasn’t been out of control in its spending for the last few years. I made a chart of the same data that:

  • Covers 20 years instead of 10
  • Takes out the recession bars so your eye does not know where to look for more or less spending
  • Uses logarithmic scaling to account for exponential growth

Can you spot the runaway spending during the Crisis? I cannot

I think this updated chart shows pretty well that the entire deficit we’re facing today was due to a falloff in tax collections prompted by a huge drop in economic activity, not runaway spending by the U.S. government.  I think this chart more accurately shows the real change in government spending due to the crisis: nearly nothing.  State governments cut back as much as the federal government expanded spending, so the net effect was as though there was no extra spending at all.

Once we take into account that nearly all of the extra federal spending went directly to prop up the banks, then this graph becomes even worse.  If we correct for this, government spending probably actually fell for normal people.

Of course, I’ve played a trick with the data. I included the 1990′s in this graph. Remember the Surpluses of the late 1990s?  I do.  Can you spot the surpluses we had in the late 1990s? No?  Me neither.  Seems likely the surpluses were due to economic growth and not any spending constraints.

Our government deficit – or surplus – is determined almost entirely by the amount of taxes collected due to economic conditions and not due to dramatic changes in spending.

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Jessie’s Wrong about MMT

February 15, 2011 Leave a comment

I am working on a long response to these three posts about MMT over at Jessie’s place.  Before I list them, I ‘ll make a few comments:

  1. He mistakes certainty in the math for religious fervor.  We’re not faith based in the MMT community, we’re math and empirically based.  (G-T) = (S-I) + (N-X)   This equation is true, and is not up for dispute.  We’re just taking 150 years of national accounting seriously, and applying it to the real world.  The conclusions that follow from taking this equation seriously are both disturbing and massively useful.
  2. He hasn’t bothered to read even the basics of MMT.  How do I know?  He quotes Alan Greenspan as being part of the MMT community because Greenspan was in charge of a fiat currency.  It’s like critiquing Austrian economics through the actions and words of Greenspan.  A critique like this would not be fair to Austrian Economics even in the smallest degree, and neither is a critique of MMT that uses Greenspan as a supporter or MMT theorist.
  3. He doesn’t understand that the knowledge of the explicit dangers of fiat currencies is a powerful tool for good.  He wants to ban fiat currencies because they sometimes end in tears. This would be like banning cars because they sometimes kill people. Understanding exactly how and why a Zimbabwe happens is a powerful tool, and understanding how and why a Japan happens is also a powerful tool.   MMT describes the path to hyperinflation and deflation with more precision and detail than any other monetary theory out there.
  4. He thinks the banks and MMT are in cahoots.  This is a laughable contention at best, and a downright evil misrepresentation of MMT at worst.  Every MMT person out there comes out against the banks. Read Randall Wray, or ponder Mosler’s famous contention “the financial sector is a lot more trouble that it is worth.”  MMT helps to destroy the biggest banks, because it takes away the “mystery power” they are given over the economy right now.

These are some of the errors he makes.  I haven’t finished the post yet, but I will be going paragraph through his posts, so I can be fair to his misguided ideas about MMT.

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Personal Food Deflation Watch: Milk $2.09/gallon at Costco

February 15, 2011 2 comments

I signed up for Costco yesterday.  I am now paying $2.09 for a gallon of milk.

I had been paying $2.79 a gallon for milk at the CVS down the block – which is a pharmacy, not even a true grocery store.

The fee to sign up for Costco was $50.  I figure that Costco will pay for itself with reduced costs on Milk, Eggs, and Butter in about 12 weeks. We buy 2 gallons of Milk per week, and have been paying $2.79, so we’re savings $1.40 per week on milk alone.  Butter is much cheaper, we’ll save $3 a week.  Eggs?  We’ll save at least $1 a week.

This is only for Milk, Eggs, and Butter.  If I throw reduced costs for meat, Costco pays for the signup costs in 5 to 6 weeks. Meat is simply much cheaper at Costco and is a major food budget expense for my family.  Paper goods are also a major expense, which are much cheaper at Costco as well.  If I throw in paper goods, Costco will pay for itself in 2 to 3 weeks.

Costco is a very, very good deal, and makes my family expenses far less expensive.  I am looking at a personal deflation of at least 10% this year in my recurring food and sundries expenses.  We will easily spend $1,400 less this year by shopping at Costco.

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Why China is not an inflation threat

February 15, 2011 1 comment

There is another whiff of panic – panic! – at a 5% China inflation print. I went through the math before in some detail. In my analysis, I assumed that China was lying and China had 10% inflation across the board – more than double the level given by the government.  Then, I also sized the Chinese economy at the maximum size.  Even if China does have 10% inflation, the inflation threat to the U.S. is very, very small.

The idea I used is that there is some amount of “total inflation” out there, and this inflation can be spread among countries.  It’s like an inflation pie – changing the cut of the pie doesn’t change the overall size of the pie.

To figure out how much total inflation we have in the inflation pie, just multiply the inflation rate by the size of the economy.  Then, you can take this “total inflation” and give it to anyplace you like.   This is similar to the idea of adjusting inflation rates through currency appreciation and depreciation – where the inflation does not go away, it just gets shifted to other places through the movement of currency prices.

Again, in the math I used the most aggressive inflation and size assumptions. I assumed an inflation rate in China that is literally double the inflation print from today.

Any reasonable assumptions about Chinese behavior, it is clear that the overall inflation threat from China is comically low.   Under the worst case for the U.S., China might be “hording” 1% of inflation from the United States.

I only included the U.S. in this analysis as a possible inflation sink.  If we include Europe and Japan as other possible sinks of inflation, the threat of China and emerging market inflation is almost nil.  Japan is changing their behavior and seem to be embracing inflation for the first time in memory, and Europe forced out the uber-hawk Axel Weber.

These huge economies are much more open to importing inflation from offshore then they may have been just a few months ago.  And they have very, very low inflation.

There just isn’t a real threat to G-7 countries from emerging market inflation.  The economies are too small to be of concern to the larger world economy.

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Is the U.K. targeting 5% Nominal GDP growth – and should we panic?

February 15, 2011 5 comments

According to David Beckworth, it is.

Nominal GDP targets are a hot topic in the economics world.  Some people think it is the holy grail, because it creates a simple, easy to understand rule that kinda sorta keeps the economy growing in a recession, and keeps a lid on inflation if there is lots of growth.

According to Beckworth, the U.K. is the home of inflation targeting, and enough people that support this rule are or were in the apparatus of the Central Bank that it makes sense to think they might be targeting 5% NGDP.

The chart the Beckworth shows is worth all the debate in the world.  That’s an very, very straight line.  5% NGDP seems to be the target for the U.K.  Note that with negative Real GDP, inflation can be higher than 5%!

So should we panic that the U.K. has a 4% inflation print?  I don’t think we should.  That line is very, very straight, with one deflationary kink. There are no inflationary kinks.  It appears that even over long periods of time the Central bank was really, really good at hitting 5.3% NGDP.

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Egypt provides a Peaceful Revolution Template for the Middle east

February 14, 2011 Leave a comment

The uprising in Egypt has shown people all over the world how to get their leaders to move to democracy.

  • Get the internet
  • Use the internet to organize massive peaceful protests
  • Keep protesting peacefully
  • Find some internationally recognized, reasonable intellectual to be the suggested leader of the new government.
  • Keep protesting peacefully

And now that we’ve seen this template work once, the entire world is watching the behavior of the military/secret police in any country where there is a revolution.  You can be assured the U.S. government has already given noticed – through non-official channels – that they will not tolerate mass slaughter.

I don’t know if there will be a string of revolutions, or if there will be a string of peaceful revolutions, but this situation in Egypt has provided people around the world with a template for a successful revolution.


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Inflation Madness!

February 14, 2011 Leave a comment

A few weeks back, I pointed out that inflation seemed to have spiked after January 1st. So I decided to do a bit more research.  Raw price data spikes every years after January 1st.

If the monthly inflation numbers continue to grow at a high rate over the next few months, I’ll be slightly concerned.  I am treating this as a Seasonal effect until then.

And there was a recent post over on Zerohedge that claimed we were having a huge price spike.  However, looking at the same data in a more traditional manner, we have a chart so boring that even I can barely stand to look at it.  Instead of showing a huge, huge spike, it shows the data in a form we’re really used to seeing. I know that 2.5% inflation really makes some people angry – they cannot stand thinking about any inflation, much less 2.5% inflation.  But overall, this rate of inflation is minor and is easily below the average inflation rate of the last 50 years.  Here is the boring chart in all of its glory:


That puts it all into a different perspective, eh?  One thing we need – more people worried about the wrong threat.

If you recall, Japan lost an entire generation of economic growth to inflation hawks.  It is one of the tragedies of the last 20 years of the 1900′s.  125 million people have had stagnant lives because of inflation that never happened.   Would Japan have flying cars already?  We’ll never know…


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