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ECB credit easing by buying debt from Greece and Spain analogous to Fed buying California and Illinois munis

The first real warning that growth in the global economy was set to decline came in April. And since then, the signs of distress have only increased. In the US, the distress is everywhere – in the housing data, the employment figures, and the manufacturing numbers. You can see the slowdown in retail sales and GDP too. What, if anything, can policy makers do? What will they do?

The monetary authority in the US was front and centre with quantitative easing – and even credit easing – the last time we saw a big push from government to prevent a deflationary spiral. I believe we may be on the cusp of a second big push and that the Federal Reserve will take the lead. One possibility few have mentioned is of the Federal Reserve buying municipal bonds. Given the talk about federal and state budget woes, this could be something they will consider. The ECB has begun to buy up Greek, Portuguese, Irish and Spanish debt in the secondary market. Why can’t the Fed buy up California, Illinois, New York and New Jersey munis?

Now, I am going to take an agnostic view in this post on what the Fed should or should not do. I just want to lay out the possibilities.

Let’s review what led us here and why I think this could happen.

QE1, credit easing and other liquidity support

In November of 2008, soon after the Lehman collapse and at the height of market panic the term quantitative easing was all the rage in policy circles. This was the policy tool that the Japanese employed early last decade after a decade of depression. The Japanese goal was to flood the banking system with liquidity by buying up government bonds with newly printed money in order to promote lending.

Ben Bernanke went one better than the Japanese with credit easing. In a famous speech at the London School of Economics, he explained what credit easing was. Reporting on this at the time I said:

Federal Reserve Chairman Ben Bernanke gave a speech at the London School of Economics today in which he outlined the measures the Federal Reserve was prepared to take in order to deal with the financial crisis. Of particular note, Bernanke indicated that the U.S. central bank would keep interest rates low and that it would buy mortgage-backed assets in order to increase its direct control over the interest rates borrowers actually see.

Bernanke also clarified his position on quantitative easing (QE), explaining that the Fed is more concerned about the asset side of the balance sheet than the BOJ (Bank of Japan) was when Japan engaged in quantitative easing. One could take this to mean that the Fed is engaging in both qualitative easing as well as quantitative easing. The Fed means to supply liquidity to the financial system and to buy poorer quality assets (i.e. Mortgage-Backed Securities instead of Treasury bonds), whereas the BOJ was merely supplying liquidity.

Of course, this is really fiscal policy more than monetary policy. In my view, the Obama Administration knew its hands were tied on fiscal policy and they leaned on the Fed to take up the slack. Moreover, the Administration was prepared to assist with its own programs. Larry Summers and Tim Geithner had experience from the Tequila crisis in which they did an end-run around Congress in bailing out Mexico via programs that did not require Congressional approval. The administration of programs like TALF, TARP, and the PPIP were designed with the innovative coup using the "Exchange Stabilization Fund" in the Tequila crisis in mind.

I see the reliance on Fannie Mae and Freddie Mac in providing liquidity to the mortgage market as a similar innovation. To allow this liquidity to continue, the Obama administration pledged to provide unlimited financial assistance to Fannie Mae and Freddie Mac on the day before Christmas 2009 – when most people were already on holiday. This allowed it to exceed the $400 billion cap on government emergency aid to the two GSEs without seeking permission from Congress. At the time, Secretary Geithner said this was just a precaution. I called it manipulating mortgages.

The Fake Recovery

By April, the fix was in. I wrote:

How to engineer recovery is another question altogether. Here again there are a set of political constraints which make things more challenging. First, there are large swathes of the population that are uncomfortable with the huge debt load and deficit spending that a stimulus-induced recovery creates. Moreover, a government-sponsored nationalisation or recapitalisation plan would only increase this deficit spending and these debts.

As a result, the Obama Administration has crafted a plan to circumvent these obstacles…

The stimulus to come from these measures is still in the pipeline and, by the end of this year, will probably add a big kick to the economy. You should note that only the fiscal stimulus required legislative approval. All of the other ‘stimulus’ has been done without Congressional approval and largely without Congressional oversight. These activities have been specifically designed to be opaque. The government’s claims of wanting to increase transparency ring hollow (see my post on Bloomberg’s suit against the Fed as an example of what is really happening).

I should also mention that the Federal Reserve has been a large factor here. It is acting in concert with the executive branch in a non-arms length fashion which I believe will have consequences regarding Fed independence down the line…

You should be under no illusion that the coming rebound is permanent. Much of it is not. What we are seeing is the makings of a cyclical recovery that might begin as early as Q4 2009 or Q1 2010. How long or robust that recovery is remains to be seen.

-The Fake Recovery

The QE1 wrecks and the fake recovery stalls

We are now at a point where the stimulus provided by these measures has worn thin. Ambrose Evans-Pritchard wrote yesterday:

"The economy is still in the gravitational pull of the Great Recession," said Robert Reich, former US labour secretary. "All the booster rockets for getting us beyond it are failing."

"Home sales are down. Retail sales are down. Factory orders in May suffered their biggest tumble since March of last year. So what are we doing about it? Less than nothing," he said.

California is tightening faster than Greece. State workers have seen a 14pc fall in earnings this year due to forced furloughs. Governor Arnold Schwarzenegger is cutting pay for 200,000 state workers to the minimum wage of $7.25 an hour to cover his $19bn (£15bn) deficit.

Can Illinois be far behind? The state has a deficit of $12bn and is $5bn in arrears to schools, nursing homes, child care centres, and prisons. "It is getting worse every single day," said state comptroller Daniel Hynes. "We are not paying bills for absolutely essential services. That is obscene."

Roughly a million Americans have dropped out of the jobs market altogether over the past two months. That is the only reason why the headline unemployment rate is not exploding to a post-war high.

Let us be honest. The US is still trapped in depression a full 18 months into zero interest rates, quantitative easing (QE), and fiscal stimulus that has pushed the budget deficit above 10pc of GDP.

In essence QE1 has wrecked and caught fire. Evans-Pritchard says:

The Fed is already eyeing the printing press again. "It’s appropriate to think about what we would do under a deflationary scenario," said Dennis Lockhart for the Atlanta Fed. His colleague Kevin Warsh said the pros and cons of purchasing more bonds should be subject to "strict scrutiny", a comment I took as confirmation that the Fed Board is arguing internally about QE2.

Buying Munis

Whether by design or coincidentally, Evans-Pritchard’s remarks are that much more meaningful as they came on the day of America’s celebration of independence. It was his remarks about Illinois and California which caught my eye, however.

There has been a lot of talk about the anti-stimulus being provided by states and local municipalities. I have noted on a few occasions that Illinois and California bonds are trading with a high degree of default risk. But Michigan is up there too. New York has serious problems as does New Jersey to name the largest and most problematic states. Most every large state in the union is in fiscal trouble, which is why I have been warning that municipal bonds should be labelled buyer beware.’

But what if the Federal Reserve started QE2 with munis as the asset class of choice for credit easing? When the European experiment threatened to unravel, the ECB chose the nuclear option and stepped into the breach to start buying up the debt of its weakest debtor states. Now, the ECB claims these actions are unsterilized i.e. it is not just printing money. But, I have my doubts. In any event, the ECB is the New "United States of Europe" as Marshall Auerback puts it. And while the limited measures the ECB has taken have not caused the credit spreads or interest rates to decline for these debtors, I guarantee you a full effort of credit easing would do.

So that get’s me to the Federal Reserve. Here’s the train of logic.

The U.S. stimulus has worn thin and money supply is now decreasing. President Obama can’t even get a bill to extend unemployment insurance through Congress. Everyone is on to this. The President talks a good game. After the latest dismal jobs numbers, Business Week quoted:

“Make no mistake, we are headed in the right direction,” President Barack Obama said yesterday after the employment report. “We are not headed there fast enough for a lot of Americans. We’re not headed there fast enough for me either.”

Personally, I think this statement is preposterous as it leads to over-promise and under-delivery. But, the fact that the President is talking about stimulus tells you he is worried since he was talking about reducing the deficit to prevent double dip in November.

In short, the President has changed his tune because he’s worried. Yet, all indications are he is going to get zero traction. Let’s remember, the Republicans can play the cynical game of ‘creating’ more short-term economic hardship to stick Obama and the Democrats with the blame.

And people are saying that the Federal Reserve is ready to start another round of quantitative easing. Ambrose Evans-Pritchard reported about 10 days ago that the Fed may be ready to double the Fed’s balance sheet from $2.4 billion to $5 trillion. Andy Lees of UBS responded saying:

As I am sure you have seen the attached story suggests that Bernanke is preparing for a 2nd program of quantitative easing; the article suggests potentially expanding its balance sheet from USD2.4trn to USD5trn. This is far from certain with him facing opposition from some of the regional Fed governors, but I think it is becoming increasingly likely that they are required to do something. It is becoming increasingly obvious that fiscal policy in the West has reached a limit and that stimulus now has to come from default through monetary stimulus, the whole purpose of which is to lift asset prices and therefore strengthen people’s effective balance sheets and thereby increase spending. I think the figures mentioned above are not required at the moment, but the longer the Fed leaves it, the more stimulus maybe needed. It is also becoming clearer that China is slowing. As I said yesterday it has started to increase liquidity injections, but I would expect a cut in the reserve requirement in the not too distant future which would indicate a bigger and more sustained liquidity injection. I’m sure the BoE is also prepared to buy more gilts as austerity starts to bite, and the ECB too.

Moreover, there has been talk about the Fed buying up long-dated Treasuries as the next unconventional measure. However, now I am thinking more unconventional: munis. With the Federal Government out of the picture, the states could re-enter the picture if the Fed went QE2 and started to buy up municipal bonds the way they started buying mortgage-backed securities in 2009. And that would give states the green light on more spending.

What do you think: all aboard, QE2 is about to disembark?

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

26 Comments

  1. dansecrest says:

    Interesting! That would be a good move (buying local bonds), in my opinion, and therefore would be opposed by Republicans…

    • The better solution would be for the US government to do per capita revenue
      sharing with the states.

      In a message dated 7/5/2010 10:55:34 A.M. Mountain Daylight Time,
      writes:

    • But its a crude ugly way to do it vs the per capita revenue sharing

      It’s a bailout for bad states, as it rewards those which spend the
      most,and it requires federally imposed fiscal discipline on the states. As the
      sole supranational entity in the EU, that’s easy for the ECB, not so easy for
      the Fed, which is already under considerable attack politically and where
      you have the existence of the Treasury.

      In a message dated 7/5/2010 10:55:34 A.M. Mountain Daylight Time,
      writes:

    • My knee jerk reaction is that this is a monetization of debt and bad. However, as Marshall says, doing this on a per capita basis would even the effects out and not reward the free riders.

      I may post on a thought I had about this because of some comments a friend of Marshall’s and me made. He said that this is a monetary problem we are facing, so a monetary solution is the best one – rather than a fiscal one. Might be food for thought.

      • Yes, Ed is correct. If you have the Fed buying the state and muni bonds, in effect you are rewarding the biggest spenders and you thereby incentivise the profligates. And the Fed, already under serious political attack, would find it hard to restrain undesirable state spending. In the case of the ECB, there is no countervailing supranational fiscal entity so it’s easier for them to enforce politically.

      • Thenoblerot says:

        oil prices to double (and every other pseudo inflation hedge) again then i suppose … great … that would really help alleviate disposable income and create aggregate demand not to mention more job creation.

  2. Attitude_Check says:

    Moral Hazard – WHO CARES if we reward the profligate. Isn’t that EXACTLY what we are trying to do.I’m sure this will encourage “real” growth in the future – somehow – but for now a sugar high before November is all that’s needed.

  3. Element says:

    “Deficit hawks should concentrate on how government policy changes the allocation of real resources in the economy rather than specific deficit targets as Rogoff and Reinhart do because that’s what drives productivity and GDP growth. …//… I have long come to the conclusion that the only thing which will cause government to change course is an even more severe depression and economic collapse. If we don’t have leaders who get it after so much hardship, what will it take?” – Money the government owes us – by Edward Harrison on 17 June 2010

    Hi Ed, been pondering this a little.

    In advance I’m not a deficit ‘hawk’. I think spending is always going to be modulated by circumstances and perceptions and political sentiments, thus having a ‘view’ about spending pro or con is irrelevant. But I object when people propound spending be on or off, like some sort of ideology light-switch.

    You’re wording above “how government policy changes the allocation of real resources”, is the same language I hear Bill Mitchell use and Marshall repeat – it’s the MMT line.

    When you say Govt policy that means Govt spending allocations.

    But I wonder what you (or the MMT’s) mean by the allocation of ‘real resources’.

    As far as I can see, Govt spending does not allocate real resources, the Govt of the day just makes the money and signs-off on public cheques. Even in the case of Defence the military advises Govt what it requires to meet the Constitutional national defence needs, within the observed and projected environment. The Govt caucus itself does not select the specific aircraft and the ships, the professional military does that, or the politics would very rapidly make defence capabilities dysfunctional.

    The military instead assesses threats and briefs Govt on the ‘threat’ (i.e. of real abilities to do physical damage and achieve unchallengable positions within own territory) and recommends options for effective defence against this on the basis of money quantity ear-marked to overturn such an attack.

    Money is just a proxy for national resources access. Money does not come out of ‘thin-air’; for if a country did not have the territory and the resources to ‘back it’ you’d have a fiat currency no one trusted (unless you made stuff people wanted, via purchasing someone else’s resources as does Japan).

    i.e. you do not need a vault full of gold to ‘back’ a currency (despite what Casey Research may think) because a countries real-resources are generally worth far more than all the fiat dollars that have ever existed.

    For instance, US soils are the deepest and most fertile in the world, making NET surplus food supplies every year in vast quantity that can be exported. There’s no dollar value for possessing that capacity, hence the USD can not go to zero value, as the national real-resources are far too abundant for that and the supply too well developed to totally suddenly collapse and cease to operate.

    Thus the US won’t get hyperinflation develop because a prerequisite of hyperinflation requires the protracted development of gross insufficiency of daily staples to meet of life’s basic needs. This also is a valuable thing to know, as it lends itself to longer-term organized Govts and relative stability. (if another JFK egomaniac doesn’t blow the world to pieces with nukes)

    Other than arguments for hyperinflation in the USA, I’m yet to read anything that suggests the USD is going to become worthless or undesirable, for some reason. Yes, it will be drastically devalued via armageddon levels of printing but it will not lose all its value entirely or cease to be accepted in trades (not entirely anyway, much like the Pound Sterling). As the value falls people will simply seek to hold and use a currency that is not being devalued so viciously. Once the Fed is finished debasing it people will start to use dollars again, and that will only be when US banks have been cleaned out, closed and debts extinguished.

    The only question is which fiat currencies will be used in the interim as that occurs? It won’t be the Euro, and it won’t be the Yen, and there’s low confidence in a Chinese currency that can’t even be floated-off a USD pegging (i.e. because it’s too lacking in credibility to stand on its own merits yet as a proxy swap to access to the state’s real-resources).

    So it seems to me the democratic OECD countries and some developing-world world countries whose currencies need to be devalued less, and have less debt, will necessarily be used more and more. And when people work this out the USD will go into a rapid devaluation. Bad if you hold USD but in my view it’s a pre-requisite for USA recovery as deflation actually finally plays out.

    The ‘money’ for a defence (the proxy for state’s real-resource access) is allocated years in advance but actual real resources are not allocated by Govt. But it’s quasi-civilian capability planners in conjunction with private defence options providers on behalf of a military who examine the issues and determine what type and what allocations of ‘real-resources’ must occur to generate a credible and competitive defence capability.

    But all this is required via constitutional stipulations, as voted for via public Referendum.

    So I don’t see what a specific Govt’s policies have to do with that spending process except with regard to foreign policy, diplomacy and defence postures. And even if the Govt makes a mess of foreign policy and upsets the neighbors, creating a much bigger threat, the military is still bound by the constitution to provide a national defence (i.e. sort of automatic stabilizer). So Defence still goes through this same processes anyway, to meet and defeat a larger threat with available dollars. And as we saw in WWII the available dollars can be whatever amount of proxy (debt/bonds) a Sovereign Govt wishes to allocate, provided it can *SUPPLY* matching resources streams in market saleable values.

    The particular Govt’s spending policy is almost irrelevant then, because it’s ultimately the people who set up this system, and who also man this military system, and who muster all the ‘real-resources’ it needs.

    This is because it was the citizens referendum that demanded it be organized this way so that vital functions that sustain society would continue to function efficiently with minimal disruption.

    I’m splitting-hairs but for a reason.

    Its because far too much emphasis is being placed upon Govt as THE agent of spending and policy formulation. Govt only administers a system set in place by the people’s choices. It’s the public service who does real policy formulation, and the so-called ‘policy makers’ simply cherry-pick the ones that suit them, and hopefully suit the people.

    Well, that’s how it’s supposed to work.

    A democratic Govt is just the people’s representative that writes legislation (which is usually done for them by public officials) then debate it ad-nauseum then vote to pass or reject it, on the people’s behalf and in there best interest (theoretically). Thus creating masses of red-tape and the need for ‘micro-economic reform’ to clean up the chronic inefficiencies and unintended consequences they have just created.

    But ultimately it’s what the electorate’s lagged demand which will determine the spending level.

    And this is what has been fundamentally derailed in the US case (and is perhaps in the early stages of being clarified) as to who is the boss of state resources and therefore its proxy access to those resources (the fiat money supply). The US is an odd-ball as it spends like crazy but not on those who need it, but on those who definitely don’t deserve it. And I think the USA is headed for intensifying civil conflict as a result of this.

    Fiat dollars only have meaning and value in relation to the ability to SUPPLY real resources on demand, and that only occurs if the CITIZENS allow these or enable these resources to be accessed.

    Which is the whole point.

    The people can prevent even the Govt from accessing state resources and from trading, via strikes, if Govt acts willfully against the majority interests to serve elite minority interests. The people can demand control of spending peacefully with the vote, or as we are increasingly seeing in Europe they can demand it much more pointedly and persistently (as we will soon see in the UK) in the ultimate form of democracy – the majority getting physical about it.

    Conservative Govts, beholden to elite interests and bankers, but who impose austerity and misery on the lower rungs of the citizenry, in order to relatively protect elite interests, are likely to get smashed as the collective comes to their senses about what is happening to their family, life and society.

    And who are the relative winners from all this? … hint: not the poor.

    Desperation will be what brings about the ‘total collapse’ you mention Ed, and a social crisis can drive that collapse just as much a liquidity crisis can and that’s what we have not yet seen in the OECD.

    But Greece is getting there. Why are Greeks CDO’s still rising? It’s because Greeks are still striking and starving the Govt of real-resources and function, until the Govt is replaced with one that will do what the people want it to do, with regard to spending and taxation, and therefore the debt must go. G-Pap can claim it’s just a minority doing this, and that most Greeks understand and support the Govt policy direction, but that just isn’t going to work.

    The process of Govt’s favoring elite-interests via spending stimulus policy and loans to protect banks is what is going to demolish these Govts, and the elite wealth behind these Govts.

    A voluntary military is made up of general society and are not going to support (for long) a Govt that supports elite interests, at the majority’s expense, in the name of ‘austerity’. Especially if a Govt has access to the printing presses and real resources to relieve the suffering at will. But what if elite interests take control of a military, and that military elite decides democratic processes and Law are not such a good idea right now as the elite-interests would like to not be answerable to either? Which is what occurred in the 1930s.

    Thus they take direct control of the proxy access to resources (fiat money), and also direct control of the actual real-resources and property.

    Then what do/can you get?

    That’s what an austerity policy to protect the rich can turn into, and that’s how conflicts can commence with little fore warning.

    Hence modulated spending, that doesn’t prejudice or undermine the poorest members of society, especially the unemployed, and the maintenance of Democratic processes, and Law enforcement that is fair and even-handed, plus keeping the military and security apparatus clean of elitist interest-serving will become more important than ever.

    i.e.

    “…If we don’t have leaders who get it after so much hardship, what will it take?” – Money the government owes us – by Edward Harrison, 17 June 2010

    That’s because the US Govt under both parties, are serving minority elite-interests who have also gained considerable control over the State security apparatus. However, in the US case they are still ready to use the printing presses … except … not to ease suffering … just to prop-up the banks that hold the money of elites.

    (Well done Hank Paulson! … the ultimate Wall Street plant)

    So I hope you aren’t ‘over’ the politics of austerity, as you recently wrote Ed, because it’s about to get very interesting. Even the so-called center-ist ‘moderates’ in the UK are being beaten into ideological submission to sign-up for austerity measures and double-dip, … and triple-dip. Though I wonder how much of this is also intended to devalue the UK currency. Well, it’s certainly doing that.

    I’m with you Ed, spending has to be modulated to relieve suffering, not to favor elite malpractice or else the dormant social volcano does its imitation of Krakatoa.

    I don’t care if someone wants to call that conclusion an ideological label (what label applies to Hank Paulson?) because we are entering a period where physical practicality and outcomes will really matter and these must trump devious politicizing and demonizing of what is non-optional essential ‘welfare’ support.

    Welfare exists because o human rights, and because it’s vastly cheaper to do it than to pay the consequences of not doing it.

    Frankly, the USA is in for very deep and bitter social conflict (if not quasi class-warfare) over this topic if conservative clown are not put in their box. The truth is the Conservatives have been by far the biggest deficit spenders of US tax dollars since WWII, but when it comes to supporting actual US people that’s considered pure evil. That US Republicans on Friday show a continuing strong desire to eliminate welfare for millions of US unemployed, when the US has massive real-resources, and a fiat dollar, and a Fed willing to print them, is an utterly devious behavior that deserves to be severely punished.

    I strongly agree however with the general German view that balanced budgets and surpluses are the ideal if you can manage them. And *if* you are not a sovereign issuer of a fiat currency – like a US state.

    Hence US States and cities should be balancing their budgets and creating surpluses and cutting wages and conditions, and the Federal Govt should be printing to support those affected rather than just propping up bank accounts of those that NEVER suffer material deprivation.

    I do not agree with austerity policy being used as an excuse to protect elite-interests via needlessly sacrificing the conditions of the poorest in a country that actually has abundant real physical resources.

    There is no excuse for that, but that’s what Brussels and London and increasingly Washington want to do to the working and non-working poor.

    Frankly, I think debt is only significant as a big issue until such time as it’s finally defaulted on – which it eventually will be. It will then cease to be a problem, but a solution.

    But this will impoverish Hank Paulson, hence Hank made it the problem for the poorest and weakest and hoped they would not get too put-out by this. So now the poor must use force to dump full responsibility back on Hank Paulson and chums.

    And that’s what the whole process that’s coming will be about and austerity propaganda and a Bank-levy is the wedge being used to stop it.

    Just watch how the austerity policy propaganda is spun out as ‘necessary’ and ‘essential’, as a ‘crisis’ must be avoided (thus guaranteeing one). And how they will attempt to make austerity appear ‘fair’, via a grandiose and sensible, but smallish Bank levy on financial transactions. And take note that it will be minimal if it is implemented at all, and most probably it won’t be.

    It’s all political theatre with one aim, to prop-up banks at any cost so all the Hank Paulson’s won’t have there bank accounts killed.

    Strikes and rioting that attack elite interests and Govt function and revenue will be what eventually shuts this down, with a blunt public demand for the elimination of public debt held by banks, rather than the current drive to eliminate public spending. Hence the UK are getting ready for a new wave of industrial relations and anti-strike laws to avoid the Sovereign default risk ramping in the bond market.

    But the UK conservatives are going to discover that this will not work, it will just make people more angry, resistant and militant, no matter what propaganda they concoct to sell-it to everyone and make them feel obliged to toe the party line.

    According to the MMT logic, described within you post, “Money the government owes us”, tax can be virtually eliminated via a fiat-issuing Govt for as long as they wish. The UK is also a country where insufficiency of life’s staples is extremely unlikely to emerge, so hyperinflation is not a danger there either. So they can certainly print and devalue a lot more yet.

    All that will then happen is countries will not want to trade in Pounds, they will require payment in a currency more likely to maintain its buying-power to obtain real resources.

    Big deal!

    And in the EU taxation case the State’s tax is eliminated and Govt spending is then funded entirely via ECB fiat that is not repaid.

    Don’t discount it Greece is almost there.

    The alternative is a disorderly and hostile abandonment of the Euro in a couple of years.

    Looks to me like all the elements are in place for a big global print-a-thon, to fight off deflation.

    I just wonder how you undo this once it’s done?

    I suspect you don’t. I suspect the Fed already can’t. It’s an irreversible change in dynamics. And Ben Bernanke has no idea what this will lead to. And the Gold bugs don’t have any clue either.

    That’s facing facts.

    What I think we are going to discover is that fiat currencies are far more flexible and far less fragile than fiat money skeptics think.

    I’ve never once seen anyone from the gold camp adequately (or in any way) explain exactly and simply why gold would add ‘backing’ to the USD in this situation, or any other major OECD fiat currency. Or why gold would be one iota more credible or workable as money, in a strongly deflating world?

    (not to mention the US already has a stack of gold … so what’s the ‘effing drama?)

    People only want access to useful real-resources (not gold) and fiat money already gives them this, and I can’t see any mechanism that would cause that to suddenly cease. Certainly inflation won’t do it, within the OECD.

    Plus I’m convinced that defaults rather than chronic 10 to 15% inflation will be the primary debt delivering mechanism, so I’m not even sure gold will be needed to buffer moderate long-term inflation (which gold investment logic also requires gold to maintain an historic high and rising price trend).

    Rationing is an ideal structure for managing rapid growth of inflation, via equalizing supply (food stamps even make price irrelevant as then only production and supply matters). Austerity leads to rationing, economic collapse leads to even more intense rationing, war leads to severe mass-rationing (plus malnutrition). i.e. austerity policy can transform into intensified rationing, as everyone is encouraged by Govt propaganda to look upon it as a patriotic duty, for the war effort, etc.

    And note that austerity is the opposite of Obama’s “spreading-the-wealth”, and “is that fair”, pre-election debate BS.

    Austerity is the transfer of pain from the wealthy to the poor – that’s all it will do.

    So I would say that being talked into austerity, as is now occurring in Europe, merely to protect banks and elite-interests must be resisted and argued vigorously against, and also acted against if imposed. History shows rationing can last for decades, and that’s totally unacceptable in real-resource rich OECD states, with fiat currencies and bankruptcy law.

    This all comes down to cleaning out banks and supporting the poor as it’s done.

    So, enjoy Obama’s deficit spending, to predominantly prop-up elite interests, a bit longer (as is currently planned through to Oct 2012), because once these deficits start shrinking fast you will finally see that austerity is very different to current State and Municipal belt-tightening. One makes you angry at City Hall while the other gives you malnutrition, frostbite, secondhand underwear, and potentially an early grave.

    Given this US slowdown is likely to re-enter a negative growth phase and both US Parties have remorselessly supported elite-interests with incredible, undeniable and impossible to hide extravagance, if the Tea-Party offers an electoral option to voters I think they will smash the power-base of both US Parties.

    And then the Obama’s budgets will be forced to flip into severe cuts, to get passed, and the fuse of austerity will be lit in the USA, as well.

    In other words;

    The people who need to understand your post “Money the government owes us”, Ed, are in the Tea party movement.

    Thus the MMT types had better get over their prejudices against the Tea Party movement, and get involved with them real fast if they want to make a difference to the policy and social and political detritus to come.

    • Look, it’s very basic. Virtually everybody who chooses to mischaracterise
      our position does so on the basis of the claim that “MMT’ers don’t care
      about what type of spending, as long as there’s spending” mistake.
      Basically, the problem is that there is about 20 years of MMT research, and
      about 1 year of MMT blogging. The 1 year of blogging has been based
      primarily on getting across the idea that sovereign govt’s are not revenue
      constrained and that the “cost” of too large deficits is inflation, not
      insolvency. Most don’t understand this, so that’s been the focus. If you do, then
      good for you. We don’t have to convince you, then. You get something close
      to full employment (i.e. something approaching 0%) and you get capacity
      utilisation at 90%, etc., etc., and you are likely to see the public sector
      bidding against the public sector for increasingly scarce resources (not
      just commodities, but also labour), in the ABSENCE OF A COUNTERVAILING PRICE
      ANCHOR, which our Job Guarantee proposal does.
      It is a BIG mistake to infer from the large number of blogposts making
      that point that there is no concern over what type of spending or deficits are
      incurred. I read this all of the time when our views are attacked. Again,
      there’s about 20 years of literature on this, and if people would read some
      of that, it would be obvious.
      And frankly, it should be obvious from the blogs, too. We’ve been very
      strongly against all the bailouts; we claimed that Obama’s stimulus package was
      poorly targeted over a year ago; we have been strongly in favor of direct
      job creation; we have been in favor of block grants to states on a per
      capita basis; we have been for a payroll tax holiday.
      All of these positions we have been repeating, probably dozens of times in
      the blogosphere, and if you haven’t seen them, then like SRW you just haven’
      t looked very hard. Disagree with the positions if you like, but really
      don’t say that we haven’t been specific about which sorts of spending or
      deficits we prefer.1. MMT is fundamentally about operations and accounting.
      It’s about what the relveant constraint are and are not. Complaining that
      MMT doesn’t tell you what type of deficit is best is like complaining that
      you can’t build a bridge before learning engineering. That sort of
      complaint just demonstrates that you’ve missed the point. Not that it’s not
      important or irrelevant, but you have to understand the operations and
      accounting BEFORE you can talk about which sort of deficit is best. We spend most
      of our time on this BEFORE problem, and too many people want to say “but
      what sort of deficit do you think we should have?” before they understand how
      it works.

      Now, some people do understand and want to move on. Good for them. But
      if they really understand MMT, then they should be able to put together for
      themselves how the rest should go, at least given their own political
      leanings. So, again, those complaining have missed the point–note the
      difference between, say, how “dave” asking about the policies and how Winterspeak
      or JKH did. Winterspeak and JKH understood the paradigm, they knew what to
      do with it, but they asked for our views on policy and were able to take or
      leave them, knowing full well that what they had gained from the paradigm
      was far more important.

      2. Having said all of that, there ARE many, many specific policy
      proposals, and one doesn’t have to look far to find them. And if you can’t find
      them, you can ask for the links and we will provide them. BUT, it should be
      recognized that the policy recommendations (a) are the result of the
      paradigm and thus are often not fully understood if the paradigm isn’t
      understood, and (b) aren’t all agreed upon by all MMT’ers (recall the point about
      “political leanings”).

      Now, given points 1 and 2 above, when people start complaining about the
      policy proposals and so forth, they are clearly missing the point. First,
      again, you can’t build a bridge without knowing engineering. Second, the
      point isn’t necessarily the MMT proposals as much as it is the
      paradigm–while we obviously think our proposals are quite good by and large, we don’t
      actually claim to have a monopoly on the optimal policy proposals emanating
      from MMT principles. That’s why the paradigm is so much more important.

      In a message dated 7/5/2010 23:15:37 Mountain Daylight Time,
      writes:

      • Element says:

        Which is all a bit odd Marshall, as I was critiquing the drive to austerity policy here that harms the less well off and protects those that don’t deserve it.

        But you thought I was ‘complaining’ about MMT policy options?

        I don’t see where.

        My relating this to MMT at the end was in relation to the need for people like yourself to get involved with what appears may be the new political button pushers in the USA. the Tea Party, so they understand it.

        i.e. so that the policy options of an MMT operational viewpoint would have some practical rather than theoretical impact – rather than none at all.

        As you have noticed in your year of MMT blogging, I and others have been paying a LOT of attention to it, and getting to terms with the ‘engineering’ bridge builders belief in what is operationally possible.

        I do believe I’ve paid careful attention to what you and others have been saying Marshall. And I believe all my comments have been fair and reasoned. Nor do I think I was in any way ‘complaining’ about MMT here.

        Get where I’m coming from now?

        • Sorry, it was late, and I inadvertently was responding to another email.
          And agree that we should try to present the ideas to the new button pushers
          in the US. In fact, people like Warren Mosler have spent a considerable
          amount of time speaking to these very people.

          In a message dated 7/6/2010 00:09:26 Mountain Daylight Time,
          writes:

          Element (unregistered) wrote, in response to Marshall Auerback:

          Which is all a bit odd Marshall, as I was critiquing the drive to
          austerity policy here that harms the less well off and protects those that don’t
          deserve it.

          But you thought I was ‘complaining’ about MMT policy options?

          I don’t see where.

          My relating this to MMT at the end was in relation to the need for people
          like yourself to get involved with what appears may be the new political
          button pushers in the USA. the Tea Party, so they understand it.

          i.e. so that the policy options of an MMT operational viewpoint would have
          some practical rather than theoretical impact – rather than none at all.

          As you have noticed in your year of MMT blogging, I and others have been
          paying a LOT of attention to it, and getting to terms with the ‘engineering’
          bridge builders belief in what is operationally possible.

          I do believe I’ve paid careful attention to what you and others have been
          saying Marshall. And I believe all my comments have been fair and reasoned.
          Nor do I think I was in any way ‘complaining’ about MMT here.

          Get where I’m coming from now?

          Link to comment: http://disq.us/g3kft

    • Element, I haven’t got through the entire of your comments yet. But I did want to say a couple of things about real resources. The MMT guys are correct when they say there is no operational constraint on federal spending because the federal government is the creator of the currency.

      See Marhsall’s post on this here:
      http://www.creditwritedowns.com/2010/03/going-off-on-rogoff-there-is-no-hard-debt-constraint-for-fiat-currency.html

      Being relatively hawkish, I tend to think we need an ‘artificial’ constraint in order to prevent government programs’ mission creep and malinvestment. I’m not talking about a formulaic Maastricht treaty approach but something which could rein in military and healthcare spending. This is a POLITICAL position more than an economic one, however.

      Behind this is the understanding that society only has a finite amount of real resources: people, capital for investment, machines, energy supply, etc. The conversation we should be having is how best for government to aid better deployment of these resources for the goods and services we want our society to have. That seems like a central role of government – even in a laissez faire environment (where the aid might come in the form of fewer restrictions rather than more government action).

      Over the last generation we have deployed too much to four areas: Military, Housing, Financial Services, Health Care. If you compare the U.S. to Germany as an example or to the composite OECD you would find this to be the case.

      What we are finding now is that the resources dedicated to these areas has resulted in high debt levels and lower longer-term growth. Policy should be oriented toward moving away from this allocation. That’s what I mean when I talk about resources.

  4. Jamesdbeadle says:

    It is hugely controversial for the ECB to be buying lower-quality sovereign debt (like Greece’s). Such a move cannot be compared with buying high quality (German) sovereign debt, or with the BoE’s buying of UK bonds. Although I like the creativity of the idea, I find it more likely that the Fed will go for treasuries, which at least ostensibly classify as risk-free. However, I could easily imagine them feeding the capital indirectly to states, perhaps via some form of special purpose vehicle.
    But, the controversy of QE2 is substantial enough without taking asset-quality risk on top if it.
    James
    http://www.market-melange.com/2010/07/04/outlook-review-4-july-2010/

    • Here I am talking about the fed buying paper of lower quality states. I don’t think anyone IS comparing buying Greek and Spanish debt to buying British or German sovereign paper.

      Do I see this as a likely scenario? Well, I don’t even know if it’s legal, first of all. Even if it is, I think we would have to see a serious liquidity crisis in the states before this comes on the table. I like it as food for thought because it expands the horizon of what you might think the central bank is capable of given the right circumstances.

      And again, I believe this would be bearish for the dollar, which is a positive side effect for those looking to depreciate the real value of debts and buoy the trading position of the US.

      • Jamesdbeadle says:

        Certainly it is interesting food for thought – I was taking it as such, and thinking about it, thanks to this post.
        And I think that drawing a comparison between “risk-free” debt (however anachronistic that label may seem to some of us) and “risky” debt is very pertinent to the likelihood of this happening.
        The Fed buying munis instead of buying treasuries is directly comparable to the ECB buying Greek debt vis-a-vis German debt.
        (With BoE debt being of comparable “quality” to German/US debt, for theoretical purposes.)
        Not criticisms, but I felt relevant comparisons for understanding the extremity of such a step. (By saying which I don’t seek to rule it out.)
        James