Thursday, 3 July 2014
Scott Fullwiler considers debt-free money.
He has just published an article entitled “Debt-Free Money” and “ZIRP Forever”. I’ve re-produced it below in green, interspersed with my comments (in black).
I wrote a while back about how neoclassical economists don’t realize their view that interest on reserves (IOR) stops “printing money” from being inflationary also means that it’s impossible to create inflation by “printing money.” See here.
I’m not 100% sure on this one (and please feel free to correct me if you know better than I do) because I admittedly haven’t given the literature a thorough read, but from what I can tell, it appears “debt-free money” advocates may not realize they are similarly overlooking the actual operations of the monetary system. So, apologies in advance if I’ve misinterpreted.
From what I’ve seen, “debt-free money” (DFM) advocates want a world in which the government spends via cash (i.e., paper money). They are against government issuing bonds or any interest on the debt, since that would suggest the government’s money isn’t “debt free” (again, please correct me if I’m wrong in this description).
Positive Money (PM) is pro DFM, and there are other organisations similarly minded in the UK, e.g. the New Economics Foundation. Plus there is “Monetative” in Germany and various other organisations in other countries.
Contrary to Scott’s above suggestion, PM is not opposed to national debts as such, though (in common with many others) they do want those debts reduced. I think PM is wrong there and advocates of Modern Monetary Theory (MMT) are right: at least I think MMT is right to say that aiming for any particular level of what MMTers call “private sector net financial assets” (PSNFA) does not make sense (and PSNFA is made up partly of government debt).
What should PSNFA consist of?
As to whether PSNFA should consist partly of base money and part debt or just base money, Warren Mosler argued for the latter. See 2nd last paragraph of his Huffington article entitled “Proposals for the banking system”. I agree with that.
So if PM does want no national debt, then they agree with Warren (and more importantly, with me..:-)).
Forcing cash onto the private sector.
What they may not realize (or they might and I just haven’t come across it), though, is that it’s not possible in a modern monetary economy to force “cash” on the private sector (note here that “cash” is not the same thing at all as “income” or “wealth,” as obviously there’s infinite demand for those). There are significant implications for neoclassicals (as I explained in the post I linked to above) and now DFM advocates as well.
Whence the idea that THEY DO want to “force” cash on the private sector? PM’s policy there is identical to MMT’s, far as I can see. That is that the authorities should create and spend money (and/or cut taxes) when the economy needs stimulus. In the latter scenario, households regard themselves as being short of cash, thus there is no need to “force” cash on them.
(A side note—as Randy Wray explained, the term “debt-free money” is a non-sequitir. I’m going to use the term here simply to identify a group of people with particular views. Also, my overarching point here is to elaborate Randy’s phrase “ZIRP forever” near the end of that post, said in reference to and in some apparent solidarity with DFM’ers.)
What happens, for instance, if I receive a $100,000 transfer from the government in paper money?
Well, I’d put 90% or more of it in the bank almost immediately. And so would almost everyone else. But this will quickly leave banks with an excess of vault cash. When banks have excess vault cash, they “sell” it to the central bank (or government, for those that want to eliminate the central bank) in exchange for reserves. But when done on any scale—as a government debt created as cash would do, on a huge scale in fact—banks are holding more excess reserves than they desire at the central bank’s target rate.
A permanent zero interest rate.
Because banks in the aggregate cannot rid themselves of excess reserves but instead simply lend/borrow them among themselves, the lending/borrowing continue until the interbank interest rate—the federal funds rate in the US—falls to zero. This is simply supply and demand—the supply curve has shifted well to the right of any point on the demand curve (which is quite inelastic to begin).
That’s no problem for me because I agree with Warren Mosler’s idea that interest rates should be zero permanently. Incidentally, Warren like Scott is an MMTer.
Why do cash hoarders deserve interest?
The following passage from Scott’s article is a bit long. Skip to the next para in black if you like.
The only alternative to ZIRP? Pay interest on these reserves at the central bank’s target rate, or drain the reserves by having either the central bank or the treasury issue longer-term liabilities like bonds or time deposits. All of these options would make the government’s “money” in the form of reserves interest bearing or even outright bonds—i.e., no longer “debt-free money” according to the DFM definition.
In fairness, this isn’t the DFM view yet; I’ve instead used the current banking system as a base case or starting point. In fact, though, the DFMers support 100% reserve requirements or a Minsky-like version of narrow banking whereby the payments system is split off from the rest of the financial system via something like post office accounts (see here).
In other words, in the DFMers preferred world there would be no “excess reserves” of the sort I used in my example above. My deposit would either be in a bank that would keep 100% in reserve or outside of the banking system entirely in a post office-like account as is done in numerous countries.
So how do we get to ZIRP in the preferred DFM world? Let’s suppose that my deposit earns 0%—a basic deposit account at a 100% reserve bank or post office/narrow bank, and consistent with the concept of DFM. Do I want to keep all of my $100,000 in an account that earns 0%? Probably not, though I might not want to put it at risk, either, or at least as close to no risk as possible. And I want it to be liquid. In other words, I want the liquid, money market-type of investments that are so popular in the current world.
These will still exist in the DFM world. They will either be through financial innovations at 100% reserve banks to get around the reserve requirement—as banks have already done for decades to get around lower reserve requirements—whereby banks offer low interest accounts with near-money liquidity. Or, they will be held in a similar sort of account at a financial institution outside of either the 100% reserve bank or post office/narrow bank system.
These accounts, as they do now, will offer low interest, money market-like rates on near money accounts with a variety of short maturities. But what will the rate of interest be on these accounts?
Think about this for a second . . . . I’m earning 0%. Almost any rate above that is better. And if the entire national debt is now in “cash” or in the narrow bank/post office or 100% reserve bank system, the total value of these balances is about 60% to 70% of GDP (according to current US numbers). Again, this is WAY more “money” than we want to hold if given an interest-bearing alternative.
So, how much do these non-bank financial institutions have to offer to get us to move our excess balances to these near-money accounts? At the margin, just a little more than 0%, much like money markets do now under the Fed’s near-ZIRP strategy.
Importantly, this means that the short-term rate of interest in the DFM economy—the equivalent of the central bank’s interbank target rate in the non-DFM world—is zero, or very close to it.
How would the central bank—or if we’ve abolished the central bank, the government or whatever centralized authority (as at least some of them have referred to it) the DFM policy makers have chosen to oversee the short-term rate of interest—raise the short-term rate? The same way a monetary authority does this now—by offering an interest bearing alternative to the zero-rate accounts at the 100% reserve banks or post office/narrow banks, and also to the near-zero rates of the near-money accounts at non-bank financial institutions.
These would be achieved using one or more of the same three methods that central banks currently use. First, the monetary authority in the DFM world could pay interest on reserves, which would enable the 100% reserve banks and/or the post office narrow banks to pay interest, forcing the non-bank financial institutions to similarly pay more interest on near-money accounts to compete for funds. Second, it could drain the reserves by offering time deposits or reverse repos to these same institutions in exchange for the reserves—this would have the same effects as the first option of paying interest on reserves. Or, third, it could issue bonds.
Scott seems to argue here that because households would have more zero interest earning money than they’d like (on the grounds that everyone wants interest on their money) ergo something has to be done about it. He suggests paying interest on reserves or that government “could issue bonds”.
My answer to that (which would also be most full reservers’ / DFMers answer I’d guess) is that just because a bunch of people have hoarded cash, there is NO OBLIGATION whatever on anyone else to reward them for doing so. And under the safe accounts advocated by full reservers, depositors get no interest (though Milton Friedman advocated investing relevant funds in short term government debt, if government actually had any interest yielding debt).
That suggestion by Friedman actually make some sense in that one of the essential characteristics of the “totally safe” accounts advocated by full reservers / DFMers is that the accounts should be – er - totally safe. And short term government debt is about as safe as cash.
What does “debt-free” mean?
Obviously, though, all three options violate DFM by paying interest on the government’s money. Government money would not be “debt-free” according to the DFM definition. In the end, from basic accounting and supply and demand, the options are to pay interest and leave the world of DFM, or live with ZIRP forever.
By “debt-free”, advocates of full reserve / DFMers don’t mean what Scott seems to think they mean. What they actually mean is as follows.
Commercial bank created money nets to nothing in the sense that for every dollar of money there is a dollar of debt (as indeed MMTers themselves often point out). In contrast, in the case of central bank created money, there is no corresponding debt. Thus central bank created money (aka “base money” aka “debt free money”) is in that sense debt free.
However, IT CAN BE ARGUED that central bank created money is a debt owed by the central bank to the holders of such money. But that’s a slightly odd meaning of the word “debt”. To illustrate, if I go along to the Bank of England with a £10 note and ask them to pay me the “debt” they owe me, I’d be told to shove off. Indeed the BoE has no legal obligation to give me anything.
I’m not sure if the DFM supporters are in favor of ZIRP forever or not. If they are, then they are logically consistent. If not, then, well, they aren’t.
Hmm. Not sure about that. Strikes me that advocating a certain amount of interest yielding government debt is consistent with the basic claims of full reserve, namely that, 1, lending entities should be funded just by shareholders, and 2, that money which depositors want to be totally safe should be just that: i.e. it should be lodged in a TOTALLY SAFE manner (e.g. lodged at the central bank and / or invested in short term government debt).
Lastly, note how this is all demonstrates what Abba Lerner (and a few others, like Beardsley Ruml at the Fed) said 60 years ago—the point of the government’s debt issuance isn’t to finance expenditures but rather to provide the private sector with an interest-bearing alternative to the government’s “money.”
That actually repeats the claim by Scott earlier in his article that there is some sort of obligation on taxpayers to reward people who choose to hoard cash. I flatly disagree with that. I’m a fan of Lerner, but if that’s what Lerner said I disagree with him.
Also, I don’t agree with the statement that “the point of the government’s debt issuance isn’t to finance expenditures..”. Strikes me that the whole point of government offering to pay interest on money deposited with them is to prevent the private sector spending that money, which in turn leaves room for government spending.
MMT has much in common with Positive Money.
So, interestingly, understanding how DFM works also illustrates the MMT view of government spending and government bond issuance. Logically we should expect that DFM supporters could join MMT in rejecting otherwise widespread concerns about government solvency, China refusing to purchase US national debt, the financial sustainability of entitlement programs, and so forth.
Agreed. I’ve been pointing out for some time on this blog that advocates of full reserve and MMTers have a few things in common. The main one being the idea that in a recession, the authorities should simply create new money and spend it, and/or cut taxes.