What happens next in Europe?

[wabuffo]

If Spain or Italy leaves the EU tomorrow, the only way they recover is by devaluing their (new) currency...ECB just needs to print more money...its so easy[/u] and yet we are all making it out to be rocket science.

Not a macro guy - but it seems to me, that it's actually not easy to create more fiat currency in the EU system.  That's because they have divorced the national political system of flexing deficit spending up and down from the central banking system.

 

IMO - there are two ways that a fiat-currency based system creates new money (ie - new net deposits in the private banking system).  I'll use the US federal system as an example:

1) Net federal spending (in excess of taxation) from the US Treasury creates new deposits in the banking system.  Federal spending creates new deposits, federal taxation removes deposits.

2) Federal Reserve supplying additional required reserves to the US banking system, when in aggregate it comes up short of required reserves.  The Fed has no choice - because it needs to support an interest rate.  A little different now with so much excess reserves.  A new private sector bank loan creates a new deposit, which if the banking sector comes up a bit short of required reserves, the Fed steps in and creates 1/10 of that new loan in the reserves.

 

Of the two - US Treasury deficit spending is the 800-lb gorilla of new money creation vs the Fed.  It isn't even close, really.  It has historically dwarfed any new reserves supplied by the Fed.

 

If we compare the US system (or Canada's or Japan's, etc) to Europe - prior to the Euro, each country had an identical system to the US.  But since the creation of the euro - France, for example is no longer like the US, it is now more like Illinois.  The EU now has a federal reserve equivalent (sort of) - the ECB, despite the banking systems still being largely nationalized.  The ECB system really got going after the first Greek banking crisis of 2011. 

 

What Europe doesn't have any is a pan-national US Treasury equivalent.  The individual national political structures can run out of money because they are more like states/provinces which face real budgetary constraints rather than fiat currency issuers that have no practical constraints (except debasement of their fiat currency due to inflation). 

 

This is a real economic problem and it has not been solved.  The ECB can't just print - it can only support interest rates and bank lending via its individual national central bank structures.

 

Without the equivalent of a US Treasury, the EU is moribund. 

 

In fact, one can argue that ECB pushing negative interest rates on national debts is like a tax since, like a tax, it is a payment from the private sector to the public sector.  I would think negative interest rates actually make things worse because they are an additional tax on an already overtaxed system.  So instead of negative rates stimulating, they are a drag (like a tax).

 

wabuffo

[JimBowerman]

"inflation is always and everywhere a monetary (not fiscal) phenomenon"

 

happy to continue the conversation but the problem (or solution) in Europe is not on the fiscal side

 

https://www.themoneyillusion.com/fiscal-and-monetary-policy-are-not-alternatives/

 

(net federal spending, budget deficits, private bank lending, etc....none of these have any long term effect on aggregate demand...only the Fed can create new reserves which is the only thing that effects NGDP in the long run. The only 800 pound gorilla in the room is the Fed, not the Treasury) Indirectly, you could argue that congress is the 1000 pound gorilla - as they dictate the Fed's mandate

[Cigarbutt]

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This is a real economic problem and it has not been solved.  The ECB can't just print - it can only support interest rates and bank lending via its individual national central bank structures.

 

Without the equivalent of a US Treasury, the EU is moribund. 

 

2-

In fact, one can argue that ECB pushing negative interest rates on national debts is like a tax since, like a tax, it is a payment from the private sector to the public sector.  I would think negative interest rates actually make things worse because they are an additional tax on an already overtaxed system.  So instead of negative rates stimulating, they are a drag (like a tax).

 

wabuffo

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Interesting thought but I guess the idea is to both promote the quantity of currency in circulation and to cause a hot potato effect with the circulating currency. In academic talk, kinda like inviting somebody to an all-you-can-eat buffet and then giving the person a laxative. I think it’s called inter-temporal optimization of spending in higher circles where common sense analogies are frowned upon.

 

Just going back in time a few years back, who would have thought that there’d be such demand for negative yielding securities? So, at the beginning of the twentieth century, there was this guy (Silvio Gesell) who came up with the idea of a self-depreciating currency. In order to encourage spending and discourage hoarding in a paradox of thrift, people would need to buy stamps (% of par value) and affix them to the currency in order to maintain its value. It seemed to anecdotally work in some places. It even got some traction in some US localities in the 1932-3 period with a multitude of “emergency currencies” that were eventually stamped down by central authorities who, I guess, felt that They were the only Ones who would eventually manage to cross the zero-bound twilight zone. And there we are.

 

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When trying to put this transition into historical context, it seems that the European Union leaders’ vision is to muddle through somehow when perhaps the question of (dis?)integration should take center stage.

[wabuffo]

The only 800 pound gorilla in the room is the Fed, not the Treasury

 

How do you explain the following -- since Jan 2010 (using the US monetary system):

 

1) The change in banking required reserves was $ 85B - which in theory the Fed created to supply the US private sector banking system.  Not sure the Fed actually had to supply all of that but whatever.  So in theory, the banking sector needed $85B in additional deposits which the Fed added through its reserve accounts.

 

2) The US Treasury spent $8.3T more than it took in federal taxes (and other receipts).  This net spending shows up as new deposits in the private sector banking system (eg social security check, payment to defense contractor for new F-35, etc...offset by income tax receipts which reduce banking deposits)

 

So $8.3 trillion for the US Treasury vs $85 billion (maybe) for the Federal Reserve in fiat money creation.  My vote is on the US Treasury as the 800-ib gorilla.  And again I point out that Europe has a Fed equivalent (ECB) but no US Treasury-equivalent.  The individual nations are more like states/provinces which are not fiat-currency issuers and thus face constraints.

 

wabuffo

[meiroy]

 

Boris Johnson: Last Week Tonight with John Oliver (HBO)

[JimBowerman]

The only 800 pound gorilla in the room is the Fed, not the Treasury

 

How do you explain the following -- since Jan 2010 (using the US monetary system):

 

1) The change in banking required reserves was $ 85B - which in theory the Fed created to supply the US private sector banking system.  Not sure the Fed actually had to supply all of that but whatever.  So in theory, the banking sector needed $85B in additional deposits which the Fed added through its reserve accounts.

 

2) The US Treasury spent $8.3T more than it took in federal taxes (and other receipts).  This net spending shows up as new deposits in the private sector banking system (eg social security check, payment to defense contractor for new F-35, etc...offset by income tax receipts which reduce banking deposits)

 

So $8.3 trillion for the US Treasury vs $85 billion (maybe) for the Federal Reserve in fiat money creation.  My vote is on the US Treasury as the 800-ib gorilla.  And again I point out that Europe has a Fed equivalent (ECB) but no US Treasury-equivalent.  The individual nations are more like states/provinces which are not fiat-currency issuers and thus face constraints.

 

wabuffo

 

Fiscal deficits only matter to the extent that the central bank allows them to matter.  See "monetary offset"

 

https://mru.org/dictionary-economics/monetary-offset-definition

 

https://www.econlib.org/archives/2016/08/monetary_offset_1.html

 

 

The example of Europe is a perfect illustration.  You can have 0% budget deficits and still get 10% inflation.  You can have -10% budget deficits and get 0% inflation. 

 

This is why, while I don't favor the fiscal rules in the EU, the primary reason nominal GDP has been sluggish in Europe is the ECB...not individual fiscal situations in the member countries. 

 

Only the ECB controls the supply of the medium of account.  Treasuries and government bonds are not mediums of account and illustrate why fiscal policy always takes a back seat to monetary policy when talking about aggregate demand.

 

By the the way, that 8.3 deficit works out to something like 5% of GDP since 2010.  Its a non issue

 

 

[wabuffo]

Fiscal deficits only matter to the extent that the central bank allows them to matter.

 

I don't understand your points.  How exactly did the Fed offset $8.3 trillion of new bank deposits created by excess Federal spending?  What mechanisms did the Fed execute to offset an increase of $8.3 trillion in net deficit spending.  And that's an AVERAGE deficit to GDP of 5% per year.

 

And one can't argue that the Fed was somehow too tight!  When the spot gold price has increased from ~$950 per oz at the beginning of 2010 to $1420 per oz today, that isn't a tight monetary policy.  Gold's characteristic is one of extreme stability so it indicates to me that the there's been a 40% depreciation in the US Dollar over this time frame vis-a-vis a very stable commodity (a North Star for monetary direction).  The Fed can't be "too tight" when that kind of a move is happening.  What is the difference between the Fed printing up $8.3T in new money and helicoptering it and the US Treasury sending $8.3T to individual private banking accounts? None - I think they are the same thing.  Except in today's monetary system, the US treasury is the heavy mover of monetary effects.

 

The Fed can't hit two policy targets with one policy arrow.  It maintains an interest rate target so it then slaves itself to US Treasury net deficit spending/bank reserve maintenance.  The last time the Fed targeted aggregate money supply was an experiment by Volcker in 1979.  Volcker himself abandoned it and replaced it with an interest rate targeting mechanism.

 

wabuffo

[JimBowerman]

Fiscal deficits only matter to the extent that the central bank allows them to matter.

 

I don't understand your points.  How exactly did the Fed offset $8.3 trillion of new bank deposits created by excess Federal spending?  What mechanisms did the Fed execute to offset an increase of $8.3 trillion in net deficit spending.  And that's an AVERAGE deficit to GDP of 5% per year.

 

And one can't argue that the Fed was somehow too tight!  When the spot gold price has increased from ~$950 per oz at the beginning of 2010 to $1420 per oz today, that isn't a tight monetary policy.  Gold's characteristic is one of extreme stability so it indicates to me that the there's been a 40% depreciation in the US Dollar over this time frame vis-a-vis a very stable commodity (a North Star for monetary direction).  The Fed can't be "too tight" when that kind of a move is happening.  What is the difference between the Fed printing up $8.3T in new money and helicoptering it and the US Treasury sending $8.3T to individual private banking accounts? None - I think they are the same thing.  Except in today's monetary system, the US treasury is the heavy mover of monetary effects.

 

The Fed can't hit two policy targets with one policy arrow.  It maintains an interest rate target so it then slaves itself to US Treasury net deficit spending/bank reserve maintenance.  The last time the Fed targeted aggregate money supply was an experiment by Volcker in 1979.  Volcker himself abandoned it and replaced it with an interest rate targeting mechanism.

 

wabuffo

 

I'd certainly argue the Fed was too tight (easpecialy in earlier parts of 2010s).  I judge the easiness or tightness of monetary policy solely on NGDP growth (which went negative in 2009) and was tepid until recently. Fed was certainly way too tight.

 

As an extreme, if you run 10% budget deficits for 10 years, you'd increase debt from 0% to 100% or there abouts.  That won't necessarily cause inflation if Fed makes it clear it won't monetize the debt faster than would be implied with 2% inflation.  It would just spread the monetization out over many years to get the 2% inflation. Thats what i mean by the term "monetary offset".

 

You can't look at even short run deltas of reserves.  Its the long term path that matters, and with reserves increasing 1000% in QE1 to QE3 we've just front loaded money printing, but the long run path of MB is remains unchanged or even below trend (hence the low NGDP growth and inflation since 2008).

 

I don't have any insights on the gold price and its way to variable to try to equate to inflation.

 

Helicopter drops don't necessarily cause inflation. I could trop $8.3 Trillion to everyone tomorrow.  That won't necessarily cause inflation because i could promise to tax it out of existance in 1 years time. Its the long term path of MB that matters.  thats why QE didn't cause inflation.  It didn't permanently change the path, it was just front loading money printing

 

More extreme, what if Fed said it wouldn't monetize any debt? then deficits wouldn't matter and maybe govt would default, but if Fed remained firm, no inflation would result.

 

The treasury can't affect aggregrate demand. they don't control the supply of the medium of account.  Treasuries are not a medium of account.  Only the dollar is, and the Fed is the sole controller of the dollar.  The treasury can't print more dollars, only bonds. Sometimes the Fed plays ball and buys those bonds and monetizes part of the debt.  But thats entirely the Feds call. They could refuse to buy any more treasuries, in which case no new dollars get out into the economy, and any deficit will either be accompanied by a future surplus or otherwise the bonds will default. Unlikely this will occur, but just list the extremes to illustrate a point

 

 

 

 

[wabuffo]

The treasury can't affect aggregrate demand. they don't control the supply of the medium of account.  Treasuries are not a medium of account.  Only the dollar is, and the Fed is the sole controller of the dollar.  The treasury can't print more dollars, only bonds. Sometimes the Fed plays ball and buys those bonds and monetizes part of the debt.  But thats entirely the Feds call. They could refuse to buy any more treasuries, in which case no new dollars get out into the economy, and any deficit will either be accompanied by a future surplus or otherwise the bonds will default. Unlikely this will occur, but just list the extremes to illustrate a point.

 

Ok - thanks for your point of view.  Needless to say I don't think this is how it works at all.

 

The US Treasury always spends first.  If the Dept of Defense wants to buy a new F-35, the US Treasury directs the Fed to credit the appropriate private banks with new deposits to pay for the plane.  The new deposits create reserves at the Fed's account with that private bank.  Bond issuance by the Treasury is after-the-spend.  The issuance of Treasury Bills or Bonds is not really debt for a fiat currency issuer.  Its an interest-rate maintenance mechanism and meets the private sector's need for interest-earning financial assets.  The bond issuance by the US treasury just moves the deposits at the Fed from a non-interest bearing account to an interest-bearing account.  On one part we agree.  The US Treasury never has to has to issue a T-bill or T-bond ever again if it wanted to, the deposits would just accumulate in the banking sector earning whatever the Fed wants to pay on reserves.  This in a nutshell is what happened from 2009 on - more or less. 

 

In practice, it can't actually happen that way, because Congress has put limits on the Fed buying Treasuries directly from the US Treasury and Congress has also limited the amount of overdraft of the US Treasury's bank account at the Fed.  It used to be $5B limit (ie, Treasury could spend up to $5B without going over - and would be forced to issue bills or bonds to prevent an overdraft - but that was changed after the GFC.  I believe now the US Treasury's account is allowed up to a $400B overdraft limit - which used to be an entire year's annual deficit).  These political constraints create the appearance that the US Treasury must borrow to spend - but as we've seen they are political and not financial or economic constraints.  Congress waived both requirements or modified them during the GFC.

 

Needless to say - I don't think we agree.  But that's ok - thanks for the engaging conversation!

 

wabuffo

[JimBowerman]

Wabuffo,

 

Agreed, and good convo! This stuff is endlessly confusing (at least for me) and I always enjoy these type of discussions and to hear other points of views.

[wabuffo]

greed, and good convo! This stuff is endlessly confusing (at least for me) and I always enjoy these type of discussions and to hear other points of views.

 

ditto - I'm always trying to learn more about macroeconomics but feel like I only scratch the surface. 

 

wabuffo