BRK Q3 Results

[wabuffo]

Can you please elaborate on this further? What would happen if there is not enough private sector demand to buy the US Treasuries offered at auction?

 

The US used to be in a fixed exchange rate currency system (where the USD was fixed to gold).  In those days & under that monetary regime, government borrowing functioned to protect central bank reserves and keep the government from defaulting on its legal conversion requirements.  In other words, the currency of the US was gold & the dollar was subordinate to gold.

 

Since holders of USDs back then had the option of conversion of their USD at the central bank, Treasury securities had to compete with that conversion option since if the market didn't like the rate, it could simply convert its currency to gold.  In addition, not borrowing by the Treasury risked excess currency from its spending also being converted to gold.  In those days, "bond vigilantes" existed and were simply the private sector buyers who could dictate the term structure of rates.

 

But that's not the monetary system of today (despite Sheila Bair & Paul Tudor Jones mistakenly believing we are still in the old regime of yesteryear).  The demand for the government's money is tax-driven.  And therefore the power of the US Treasury to impose a tax liability ONLY payable in its own currency is sufficient to create a demand for the currency and give it value.

 

In today's system, if the US Treasury decides not to issue securities, all rates will gradually fall to zero (which is the natural rate for a government that is a monopoly issuer of its currency).  Thus there is ALWAYS demand for Treasury securities since the alternative is a zero rate.   This is because Treasury security issuance in this regime isn't borrowing but instead acts as a reserve drain.  If those reserves aren't removed, rates go to zero (or even negative).

 

Let's use 2021 as a practical example. 

 

Due to a combination of factors, from January to October, the US Treasury spent down its reserves in its general account at the Fed by $1.5t but only issued $500b of net new securities due to its debt limit toggling back on.   Meanwhile the Federal reserve was also buying $750b causing the private sector to actually be short by $250b.  

 

The result of net spending to the private sector of $1.5t and converting another $250b of private sector ownership of Treasury securities to cash caused reserves to surge.  The Federal Reserve by March-April began to get alarmed that the growth of reserves was heading to over $5t.   There were reports back then that banks would start to push some depositors out and that money market funds would start to charge an admin fee to cover their costs (ie, negative interest rate).   

 

The collapse of rates to below zero was about to happen & thus, if the US Treasury couldn't or wouldn't remove those reserves through "borrowing", the Federal Reserve would have to conduct its own "borrowing" to drain reserves.  If it didn't, then the Fed would lose control of its target rate of interest.  The Fed's "borrowing" was in the form of a huge reverse repo operation that reached $2.2t.

 

So one arm of the govt (Treasury) issues securities to remove reserves - or - another arm of the govt (Federal Reserve) issues securities (reverse repo) to remove reserves.  Either way, both have the same goal - to control a policy rate by draining reserves.

 

Both of these assets end up on the balance sheet of US money market funds (T-Bill or reverse repo at NY Fed).   But we think of the former as borrowing while the latter is a monetary operation - yet they are the same in result.  Note also that the source of the funds to buy the securities or do the reverse repo comes from the deficit spending & thus is pre-funded and does not crowd out private sector wealth.

 

Bottom line - in today's monetary regime, US Treasury securities are not really borrowing (in the conventional way we think of borrowing).  They are a reserve drain to control rates and there is always demand for these securities because of the deficit spending that precedes them.  

 

The only constraint is possible inflation but that's another topic.   The only thing I will say there is that the USD is the world's reserve currency and must supply not just domestic dollar needs but foreign demand for dollars.   So perhaps the question isn't should the US run a deficit but what is the optimal size of that deficit as a % of GDP.   And given the US is a $30t GDP economy, perhaps a 5-6% deficit is more optimal than a 1-2% one.  But 5% of $30T is still a very large number and is "scary"

 

<Sorry for turning a BRK Q3 thread into macro babble - stuff interests me, but I understand that for most people its probably dull & wonky>

 

Bill

Edited November 5 by wabuffo

[Jaygo]

^^^ This is great. Hard to fully grasp but thanks for the details. 

 

Do you think Buffett understands this too judging by his actions?

[dealraker]

7 minutes ago, wabuffo said:

Can you please elaborate on this further? What would happen if there is not enough private sector demand to buy the US Treasuries offered at auction?

 

The US used to be in a fixed exchange rate currency system (where the USD was fixed to gold).  In those days & under that monetary regime, government borrowing functioned to protect central bank reserves and keep the government from defaulting on its legal conversion requirements.  In other words, the currency of the US was gold & the dollar was subordinate to gold.

 

Since holders of USDs back then had the option of conversion of their USD at the central bank, Treasury securities had to compete with that conversion option since if the market didn't like the rate, it could simply convert its currency to gold.  In addition, not borrowing by the Treasury risked excess currency from its spending also being converted to gold.  In those days, "bond vigilantes" existed and were simply the private sector buyers who could dictate the term structure of rates.

 

But that's not the monetary system of today (despite what Sheila Bair & Paul Tudor Jones believing we are still in the old regime of yesteryear).  The demand for the government's money is tax-driven.  And therefore the power of the US Treasury to impose a tax liability ONLY payable in its own currency is sufficient to create a demand for the currency and give it value.

 

In today's system, if the US Treasury decides not to issue securities, all rates will gradually fall to zero (which is the natural rate for a government that is a monopoly issuer of its currency).  Thus there is ALWAYS demand for Treasury securities since the alternative is a zero rate.   This is because Treasury security issuance in this regime isn't borrowing but instead acts as a reserve drain.  If those reserves aren't removed, rates go to zero (or even negative).

 

Let's use 2021 as a practical example. 

 

Due to a combination of factors, from January to October, the US Treasury spent down its reserves in its general account at the Fed by $1.5t but only issued $500b of net new securities due to its debt limit toggling back on.   Meanwhile the Federal reserve was also buying $750b causing the private sector to actually be short by $250b.  

 

The result of net spending to the private sector by $1.5t and removing another $250b caused reserves to surge.  The Federal Reserve by March-April began to get alarmed that the growth of reserves was heading to over $5t.   There were reports back then that banks would start to push deposits out and that money market funds would start to charge an admin fee (ie, negative interest rate).   

 

The collapse of rates to below zero was about to happen & thus, if the US Treasury couldn't or wouldn't remove those reserves, the Federal Reserve would have to conduct its own "borrowing" to do a reserve drain.  If it didn't, then the Fed would lose control of its target rate of interest.  The Fed's "borrowing" was in the form of a huge reverse repo operation that reached $2.2t.

 

So one arm of the govt (Treasury) issues securities to remove reserves - or - another arm of the govt (Federal Reserve) issues securities (reverse repo) to remove reserves.  Both have the same goal - to control a policy rate.

 

Both of these assets end up on the balance sheet of US money market funds.   But we think of the former as borrowing while the latter is a monetary operation.   Yet they are the same.  Note also that the source of the funds to buy the securities or do the reverse repo comes from the deficit spending & thus is pre-funded and does not crowd out private sector wealth.

 

Bottom line - in today's monetary regime, US Treasury securities are not really borrowing (in the conventional way we think of borrowing).  They are a reserve drain to control rates and there is always demand for these securities because of the deficit spending that precedes them.  

 

The only constraint is possible inflation but that's another topic.   The only thing I will say there is that the USD is the world's reserve currency and must supply not just domestic dollar needs but foreign demand for dollars.   So perhaps the question isn't should the US run a deficit but what is the optimal size of that deficit as a % of GDP.   And given the US is a $30t GDP economy, perhaps a 5-6% deficit is more optimal than a 1-2% one.  But 5% of $30T is still a very large number.

 

<Sorry for turning a BRK Q3 thread into macro babble - stuff interests me, but I understand that for most people its probably dull & wonky>

 

Bill

It seems then that Jeffrey Gundlach is also out-of-the actual reality as too his thinking.  Interesting.  

[wabuffo]

Do you think Buffett understands this too judging by his actions?

 

He absolutely does.  He has said that he thinks deficits are fine so long as the deficit-to-gdp ratio rises in line with economic growth.   I think he believes the real problem is the trade deficit because he thinks that those US dollar assets leaving the country are claim checks that can only be spent in the US economy and will come back some day as inflation.

 

But I could be wrong about his position.

 

Bill

Edited November 5 by wabuffo

[Spooky]

Thanks @wabuffo. I always learn something from your posts. The plumbing of the US financial system is so interesting (and complicated haha).

[Spooky]

6 minutes ago, wabuffo said:

He absolutely does.  He has said that he thinks deficits are fine so long as the deficit-to-gdp ratio rises in line with economic growth.   I think he believes the real problem is the trade deficit because he thinks that those US dollar assets leaving the country are claim checks that can only be spent in the US economy and will come back some day as inflation.

 

He wrote an article in fortune about this back in Nov. 2003: America’s Growing Trade Deficit Is Selling the Nation Out From Under Us.

 

 

[UK]

23 minutes ago, Spooky said:

 

He wrote an article in fortune about this back in Nov. 2003: America’s Growing Trade Deficit Is Selling the Nation Out From Under Us.

 

 

 

It seems he even proposed an interesting solution:)

 

https://en.wikipedia.org/wiki/Import_certificates

 

Edited November 5 by UK

[gfp]

40 minutes ago, wabuffo said:

<Sorry for turning a BRK Q3 thread into macro babble - stuff interests me, but I understand that for most people its probably dull & wonky>

 

Bill

 

Thanks for taking us to Mosler / Wray / Wabuffo school Bill!  We always appreciate it

 

edit: at the risk of going further off-topic, I was just thinking of Warren Mosler last night as I was learning about McMurtry automotive's insane fan car that uses a system of fans, basically a vacuum under the car, to produce unbelievable downforce without the usual drag that aerodynamic downforce would create.  Plus an insane power to weight ratio.  But the motors are electric so not a fair comparison to Mosler's work.

https://mcmurtry.com

Edited November 5 by gfp

[73 Reds]

3 minutes ago, gfp said:

 

Thanks for taking us to Mosler / Wray / Wabuffo school Bill!  We always appreciate it

Not to get off topic but I never understood the gold standard.  Why not a more useful commodity, like oil or steel?

[Hektor]

1 hour ago, wabuffo said:

 

<Sorry for turning a BRK Q3 thread into macro babble - stuff interests me, but I understand that for most people its probably dull & wonky>

Thanks @wabuffo

[wabuffo]

Not to get off topic but I never understood the gold standard.  Why not a more useful commodity, like oil or steel

 

Too unstable.  Gold was useful because its low annual production/above ground inventory made it stable.

 

Unfortunately above ground supply grows too slowly.  

 

Bill

[hasilp89]

15 minutes ago, wabuffo said:

Not to get off topic but I never understood the gold standard.  Why not a more useful commodity, like oil or steel

 

Too unstable.  Gold was useful because its low annual production/above ground inventory made it stable.

 

Unfortunately above ground supply grows too slowly.  

 

Bill

Interestingly Ben Graham was a proponent of this (multi-commodity backed currency) 

https://www.amazon.com/Commodities-Currency-Benjamin-Graham-Classics/dp/0070248060

 

https://www.ivey.uwo.ca/media/2826068/bengraham2ndsymposium-potvin-power-point-2009.pdf

[Xerxes]

13 hours ago, wabuffo said:

There are no bond vigilantes.  There is no “crowding out”.

Hi. wasn’t the vigilantes a thing in Clinton era in the 1990s. That is well pass the gold standard. 
 

or did I misunderstood your comment ?

[wabuffo]

wasn’t the vigilantes a thing in Clinton era in the 1990s. That is well pass the gold standard. 

 

Doesn't matter - people still think there are bond vigilantes today.  What matters is putting on your tool belt and trying to understand how the US monetary plumbing works.  

 

BTW - I don't consider myself an MMT-er.  Some of those folks are more interested in policy that I often disagree with.

 

This idea of tax-based money used to be pretty mainstream even a century ago.   Instead I pick and choose from among different economic theories and merge them into a framework of what seems to practically work based on the evidence.

 

Bill

[Castanza]

2 hours ago, Spooky said:

 

He wrote an article in fortune about this back in Nov. 2003: America’s Growing Trade Deficit Is Selling the Nation Out From Under Us.

 

 

 

Article for anyone interested

 

https://money.cnn.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm

 

Clip of Buffett and Munger on it:

 

 

 

Edited November 5 by Castanza

[Xerxes]

8 minutes ago, Castanza said:

 

Article for anyone interested

 

https://money.cnn.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm

Blast from the past from 1984. Four key topics:

 

- Kremlin

- Lebanon in Chaos

- Reshaping NATO

- Monster deficit 

 

same topics as today, but 4 decades pass. Back to future. 

 

[Spooky]

24 minutes ago, wabuffo said:

wasn’t the vigilantes a thing in Clinton era in the 1990s. That is well pass the gold standard. 

 

Doesn't matter - people still think there are bond vigilantes today.  What matters is putting on your tool belt and trying to understand how the US monetary plumbing works.  

 

BTW - I don't consider myself an MMT-er.  Some of those folks are more interested in policy that I often disagree with.

 

This idea of tax-based money used to be pretty mainstream even a century ago.   Instead I pick and choose from among different economic theories and merge them into a framework of what seems to practically work based on the evidence.

 

Bill

 

Is the monetary system in the UK significantly different than in the US? Seems like the bond Vigilantes have been out in force there.

 

[wabuffo]

Is the monetary system in the UK significantly different than in the US? Seems like the bond Vigilantes have been out in force there.

 

It is not - the UK, Japan, Canada are all examples of sovereign currency issuers.   The Euro is a bit different since it is a monetary union and individual countries have ceded their currency sovereignty.  Individual European countries are more like states or provinces now.

 

Bill

[Spooky]

2 minutes ago, wabuffo said:

Is the monetary system in the UK significantly different than in the US? Seems like the bond Vigilantes have been out in force there.

 

It is not - the UK, Japan, Canada are all examples of sovereign currency issuers.   The Euro is a bit different since it is a monetary union and individual countries have ceded their currency sovereignty.  Individual European countries are more like states or provinces now.

 

Bill

 

How do we square the discussion above with the jump in UK gilt yields after a) the budge proposed by Liz Truss' causing a collapse of her government; and b) the recent jump in gilt yields after the recent Starmer budget? I guess under a) the Bank of England needed to get involved.

[wabuffo]

I would not focus too much on short-term price changes. The UK seems to be swinging wildly in terms of govt policy. The last worry about gilts in Oct-Nov 2022 didn’t last long but I don’t follow UK flows.
 

Bill 

Edited November 5 by wabuffo

[Munger_Disciple]

Thanks  @wabuffo. Great tutorial and you are the best!

 

I think Sheila Bair was talking about possible increase in LT rates. Naturally the treasury determines the composition of the treasury debt issued but can they keep controlling the LT rates with increased deficit spending forever by issuing mostly ST treasury bills? Doesn't the private sector at some point have a say in determining the LT treasury rates?

[cubsfan]

It may be a derailment from the thread, but a very valuable discussion. I found the Paul Tudor Jones CNBC interview very alarming, because it seem to make so much sense when you look at the trajectory of the deficit. But I certainly do understand the plumbing, and the reserve currency topics.

 

Many thanks.

[Parsad]

7 hours ago, 73 Reds said:

Not to get off topic but I never understood the gold standard.  Why not a more useful commodity, like oil or steel?

 

Portability to act as a currency.  Can you imagine trading barrels of oil at the grocery store or chunks of rebar?!    Cheers!

[Castanza]

2 minutes ago, Parsad said:

 

Portability to act as a currency.  Can you imagine trading barrels of oil at the grocery store or chunks of rebar?!    Cheers!

Grocery stores don’t even take $50 bills anymore (which is insane). Doubt they’re taking gold! In fact most banks won’t take gold if you walk in with some. 

[Parsad]

6 minutes ago, Castanza said:

Grocery stores don’t even take $50 bills anymore (which is insane). Doubt they’re taking gold! In fact most banks won’t take gold if you walk in with some. 

 

No, they won't.  But if the shit hits the fan and no one has confidence in fiat currency, they would probably start to accept it.  You can buy small micro cards of gold now online, where you can break off tiny pieces.  So it might be a 10 gram thin rectangle, and pre designed so you could break off a small 1 gram square to buy goods with...rather than carrying around troy ounces of gold to try and trade with.  Cheers!
 

https://www.herobullion.com/valcambi-100-x-1-gram-gold-combibar/?srsltid=AfmBOoroy-bG5ZOpJzZWbkc0Zk9nV8Nh-FCeQtgrCOoT0cmQ18vVj9z6