Monthly Archives: July 2009

Schwarznegger to Obama: Watch and Learn

Posted on July 12, 2009 by admin | 14 comments

According to the San Diego Union-Tribune, Republicans and Democrats alike embraced legislation last Friday that would make California IOUs legal tender for all taxes, fees and other payments owed to the state.

Effectively, California is using its IOUs to create a currency. If this bill passes it would allow California to deficit spend just like the Federal Government and with the IOU’s acceptable as payment of state taxes, it instantly imparts value to them (see here and here). In effect, what you have is a state of the union creating a sovereign currency right under the noses of Treasury, Fed. They are stumbling their way into it, and as they do so, some of the true nature of contemporary money is being revealed. It will be viewed as a stop gap measure at first, and then could very well become entrenched as states realize they have a way to escape balanced budget requirements.

Contrary to most conventional economic thought, whereby people think we pay taxes to create revenue, in fact, it works the other way around under a fiat currency system. The government doesn’t need money to spend, but in fact uses tax to manipulate aggregate demand, not raise funds to “pay” for government. The tax is what gives the currency its value insofar as taxes function to create the demand for federal expenditures of fiat money, not to raise revenue per se. Value has been given to the money by requiring it to be used to fulfill a tax obligation, but the money is already in existence, not “created” by the revenue.

Most significantly, the Federal government retains this monopoly under our existing monetary arrangements. If California is successful here in allowing its IOUs to pay tax, it has profound constitutional ramifications. It certainly means considerably less muni bond issuance in the first instance, if the proposal passes constitutional muster.

It will be interesting to see what the exchange rate is between California IOU and US currency – the IOUs do offer a yield, so should be less than par by design. I wonder if NY is next.

This is like some sort of return to the 13 colonies with all kinds of ersatz currency floating about. It’s hard to believe the Rubinite wing of the Democrats will just let it be, given the threat it represents to Wall Street’s prevailing economic interests, but it is an understandable response to a federal government which continues to champion the interests of the rentier class above the vast majority of Americans by emphasizing “fiscal sustainability” and destroying aggregate demand in the process.

There are political benefits for Obama, as Mike Norman has noted, to rid himself of the shackles of conventional (and wrongheaded) economic thinking: If the Federal government allows this proposal of the state of California to go unchallenged, it would relieve the President of a major political quandary, which is, does he help California and then open himself to aid requests from other states? (Which his advisor, David Axelrod doesn’t want), or, does he let California go and lose 56 electoral votes in the next election?

By allowing them to “solve” their own problem in the manner proposed by the legislation he avoids the quandary. And given that, from a money paradigm at least, he and his team probably don’t know how destabilizing (to the current system) this is, they just might let them do it until the import is fully understood.
It is true that this legislation represents a profound break from all federal laws. It is almost bound to incur some sort of constitutional challenge, representing as it does, a profound threat to the Federal government’s currency monopoly powers. But this is another instance where Obama’s inattentiveness to the ramifications of the states’ respective fiscal crises has come back to haunt him. This situation would not have arisen had Obama embraced a simple revenue sharing plan with the states (so that the states’ respective fiscal policies would be working in harmony with his proposals, rather than mitigating the impact of the Federal fiscal stimulus), as recommended by any number of prominent economists, such as James K. Galbraith of the University of Texas.

It will be interesting to see how this plays out. As California goes, will the nation follow? Will we ultimately be confronted with the spectacle of “President Schwarzenegger” trying to legalize the drug output of the Emerald Triangle so he can tax it, thereby enabling us to shut the borders on the rest of this mess? Arnold always wanted to be President, but Constitution would need to be changed. Maybe this is his path to President of the 8th largest nation?

14 Comments

Posted in Marshall Auerback, The Federal Government Deficit, The National Debt, Uncategorized

Tagged Fiscal Policy, Marshall Auerback, The Federal Government Deficit, The National Debt

Why Negative Nominal Interest Rates Miss the Point

Posted on July 11, 2009 by Scott Fullwiler | 23 comments

By Scott Fullwiler

Willem Buiter, Greg Mankiw, and Scott Sumner have all recently proposed negative nominal interest rates on reserves or currency as a way to stimulate consumer spending and bank lending. It may be nothing more than a coincidence, but the Swedish Riksbank just set the rate it pays banks on reserve balances at -0.25%, effectively taxing banks for holding reserve balances. But I think they are all missing the point, and here’s why.The classic example of a negative nominal interest rate—long suggested by a number of economists for avoiding deflation—is a tax on currency, which can be summarized in an example Mankiw provides:“Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent. That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10. Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw — it’s a benefit.”
Continue reading →

23 Comments

Posted in Scott Fullwiler

Tagged Federal Reserve, Monetary policy

The Fed As Super Duper Regulator? Will We be Duped Again?

Posted on July 10, 2009 by admin | Comments Off

By L. Randall Wray

Treasury Secretary Geithner is floating a plan that would consolidate more power in the hands of the Fed. The idea is that because it failed so miserably over the past decade to recognize a series of asset bubbles and growing systemic risk, it should be placed in charge of assessing and controlling systemic risk. You’ve got to love the logic. Could it have anything to do with the fact that Geithner came from the NY Fed where he used to cozy-up to Wall Street banks?

Three economists with widely different perspectives trashed the idea in hearings before the Subcommittee on Domestic Monetary Policy and Technology, Committee on Financial Services, U.S. House of Representatives, July 9, 2009.

“I do not know of any single clear example in which the Federal Reserve acted in advance to head off a crisis or a series of banking or financial failures,” said Allan H. Meltzer, professor of political economy at Carnegie Mellon University and the author of a history of the Fed.

John Taylor went on: “The administration proposal would grant to the Fed significant new powers, more powers than it has ever had before,” he told lawmakers. “My experience in government and elsewhere is that institutions work best when they focus on a limited set of understandable goals.”

James Galbraith, a long time Fed critic weighed in:

“Chairman Greenspan actively encouraged consumers to sign up for the innovative adjustable-rate mortgage products that would, eventually, destroy the system. Right up to July, 2007 in public statements and testimony before Congress, Chairman Bernanke continued to say that problems in the housing sector were manageable, and that the “predominant risk” was inflation. No doubt this emphasis reflected the macroeconomic priorities of the Federal Reserve at the time. Perhaps there was, also, a calculated desire to maintain public confidence. But that is precisely the problem. An effective systemic-risk regulator would not have those conflicting considerations.”

Those who followed the 1980s Savings and Loan fiasco will recall how that crisis was created by Chairman Volcker’s decision to raise interest rates to historic levels no matter how much that devastated the nation’s thrifts plus a hands-off treatment by regulators—who actually encouraged them to take on big risks to try to grow their way back to profitability. Indeed, top regulators saw their role as something akin to “cheerleading”, best represented by FDIC Chairman William Seidman’s enthusiastic statement that “bankers are our friends”, so encouraged his agency to operate like a “trade association” for the industry. Needless to say, cheerleaders do not make good regulators. (See my article here)

To be sure, the FDIC has done a much better job in recent years (and Chairwoman Sheila Blair has been a thorn in the side of both Geithner and previous Treasury Secretary Paulson). In his testimony Galbraith makes a good case for putting the FDIC—not the Fed–in charge of regulating systemic risk. The reason is that bankers more easily capture the Fed for the simple reason that most decision-making takes place in Washington at the FOMC meetings, where the regional Fed presidents take turns voting on monetary policy. Many of these come directly out of the banking sector (of course Chairman Bernanke does not), and all represent the interests of their member banks. Don’t forget, the private banks own the Fed, although the Fed is legally a creature of Congress. Imagine the outcry if we sold the Treasury to the highest bidder to create a similar Frankenstein creature. (A cynic might argue that “Government Sachs” already bought the Treasury—but let’s not go there.)

Whether the Super Duper Regulator is placed under the auspices of the FDIC, the Fed, or elsewhere, however, I am skeptical that it will do much good in the absence of thorough-going reform of the financial system. The fact is that the biggest financial institutions are too big to supervise, too powerful to regulate, and too big to fail. Practically by definition, anything that hurts the profitability of one of these behemoths will increase systemic fragility. Further, as students of the S&L crisis know, powerful financial institutions are able to buy lots of friendship in Congress (think Charles Keating and Senator John McCain).

Thus, it appears that the proposal for a Super Duper Regulator is an attempt to make a run around any real reform, which would have to start with the recognition that any institution that is too big to fail and too big to manage and too big to supervise and too big to regulate is also too big to save, thus, too big to retain.

Comments Off on The Fed As Super Duper Regulator? Will We be Duped Again?

Posted in L. Randall Wray, Policy and Reform, Uncategorized

Tagged Federal Reserve, L. Randall Wray, Policy and Reform

Sovereign State of California (An Update)

Posted on July 10, 2009 by admin | 8 comments

by L. Randall Wray

Finally, there is some good news out of California:

SACRAMENTO — State vendors and contractors could use their government-issued IOUs to pay state taxes, fees and liens under a bill approved by an Assembly committee. The Business and Professions Committee unanimously passed the bill by Assemblyman Joel Anderson during its first legislative hearing Tuesday. The bill requires the state to accept its own IOUs as payment for money owed to the government.

As a stopgap measure, this will ensure a demand for the state’s IOUs. Each individual vendor, contractor, or even state employee will accept the state’s new warrants up to the individual’s expected tax liability. Eventually the warrants will also be accepted by retail establishments and others who also have liabilities to the state of California—meaning that the state could (eventually) issue a number of warrants equal to the total of all such obligations owed to the state, on an annual basis.

The next step is to issue these IOUs at zero interest. The taxes, fees, and liens will be sufficient to generate a demand without promising interest. Currency is simply an IOU that does not pay interest—it is “current”. As I suggested before, the state can also accept its own “currency” in payment of fees and tuition paid to state institutions of higher learning—further increasing demand.

Unlike other local currencies around the country—such as the BerkShare in Massachusetts, the new California currency will be “tax driven”, thus sustainable. In other words, it is a sovereign currency backed by the state’s ability to impose taxes. As California is reportedly the eighth largest economy in the world, a new Bear Flag Dollar ought to do fairly well internationally (meaning in the United States and abroad).

It is amazing that the Obama Administration is ignoring the fiscal crisis in that state (and in all states). Since Arnold cannot run against Obama in the next election, he can at least threaten to secede and run for President of the new Great Nation of California. Mike Norman has outlined a nice game of chicken he could play:

“Here’s what Arnold can do, and I’ve said this before: Declare himself President of California and secede from the Union. Then he can issue his own currency (which is what these I.O.U’s are, effectively). After that, there’d be a short war and California would be brought back into the U.S. and war reparations would be paid to the state. (Possibly far more than what the state was asking for anyway.)”

Perhaps it is a bit far-fetched, but better than going bankrupt quietly—think Orange County in 1994 or New York City and State in 1975-76. See also John Avalon’s thoughts on the possible bankruptcy of both NY and CA.

Hey, here’s an idea. Why don’t all 50 states secede, form a Second United States, issue a New Dollar, and ramp up spending to the required level to get the national economy as well as the economies of the 50 states on a path to full employment?

8 Comments

Posted in L. Randall Wray, Taxes, Uncategorized

Tagged Government's IOU, L. Randall Wray, Taxes

Think Unemployment Claims Show a Glimmer of Hope? Think Again.

Posted on July 9, 2009 by Pavlina Tcherneva | 4 comments

by Pavlina R. Tcherneva

Last week 565,000 people filed first time jobless claims. Although this is the smallest number since January 2009, it is hardly cause for celebration. The unemployment claims data is highly volatile, and numbers reported during holiday weeks are especially poor indicators of employment trends. More telling is the number of continuing unemployment claims, which hit yet another record high of 6,883,000.

While many economists think that the economy is experiencing a labor market shock which will correct sooner or later, data on the duration of unemployment paints a different picture. Problems with the labor market have been brewing for decades.

Continue reading →

4 Comments

Posted in Pavlina R. Tcherneva

Tagged Policy and Reform, unemployment

Time For the Third Stimulus Package

Posted on July 9, 2009 by admin | 4 comments

by L. Randall Wray

According to Paul Krugman “voices calling for stronger stimulus are, may I say, sorta kinda respectable — several Nobelists in the bunch, plus a large fraction of the prominent economists who predicted the housing crash before it happened.”

Professor Krugman provides a link to those who argued that the second stimulus was too small, as well as to those who are already calling for a third stimulus. Three UMKC-affiliated professors are listed, including yours truly. With some immodesty, I’d like to point out that Wynne Godley and I were already calling for a stimulus package in 1999. We were worried that a tightening fiscal stance forced our economy to rely on unsustainable private sector deficits. We said:

“Growing government budget surpluses combined with growing trade deficits have generated record private sector deficits. Unless households continue to reduce their saving—creating an increasingly unsustainable debt burden—the impetus that has driven the expansion will evaporate.”

Of course the economy did quickly collapse into recession, but emerged due to restoration of a budget deficit plus a growing domestic private sector deficit. Over the years, many of us continued to warn that the budget remained too tight while private sector deficits were unsustainable. It all went on far longer than we expected, which does not prove us wrong but rather means that the slump will be immensely worse than it would have been had it come to an end earlier. That is why many of us believe the stimulus is orders of magnitude too small. The private sector is left with a monumental debt overhang and things will not get better until private balance sheets recover.

The best thing that the government can do now is to stop the job losses and to start creating jobs. We are not talking about a couple of million new jobs at this point—we need 6.5 million to replace those already lost, plus another 1-2 million to provide jobs for those who would have entered the labor force (high school and college graduates, for example) if the economy had not collapsed. Reports this morning show that President Obama’s approval rating is falling—below 50% in the swing state of Ohio—and job loss is a big part of the reason. Pessimism is setting in and it will be hard to overcome because it is well-founded. Job losses are devastating for communities—retailers are hit, real estate prices continue to fall, and state and local governments are forced to cut spending.

Many are looking back to 1937, when fiscal policy inappropriately tightened and threw the economy back into depression; indeed the collapse in 1937 was faster than the original crash that started the Great Depression off. To some extent that is not the correct analogy because most of the second stimulus package has yet to be spent, and recent data reported by Mike Norman shows that the federal deficit has actually increased in recent days. But it is still not enough, as evidenced by the growing economic stress around the country.

I realize that it is important for Congress to settle on some dollar figures for a third stimulus because that is the way that budgeting works. But in truth it is impossible to say beforehand how much we will need to stop the carnage. As James Galbraith has been warning, it is better to err on the upside. So far we have done the opposite—with the predictable result that the economy continues on a path toward another great depression.

4 Comments

Posted in L. Randall Wray, Policy and Reform, The Federal Government Deficit, Uncategorized, Unemployment

Tagged A Minskian New Deal, Fiscal Policy, L. Randall Wray, Policy and Reform, The Federal Government Deficit, unemployment

Loans, Asset Purchases, and Exit Strategies—Why the WSJ Doesn’t Understand the Fed’s Operations

Posted on July 9, 2009 by Scott Fullwiler | 18 comments

by Scott Fullwiler

Some may have noticed a few weeks ago when the European Central Bank – the counterpart to the Federal Reserve in the Eurozone – conducted a one-day operation that resulted in $622 billion in 1-year loans to the European banking system. At the time, I and others wondered where the fanfare was, as a similar operation by the Fed would surely have resulted in an outcry about the inflationary impact of such a large “liquidity” injection. But a piece by Simon Nixon in the Wall Street Journal explains why there was so little fanfare. As Nixon put it:

Continue reading →

18 Comments

Posted in Scott Fullwiler

Tagged Federal Reserve, Monetary policy

A Twelve-Step Program for Economic Recovery

Posted on July 7, 2009 by admin | 8 comments

by Stephanie Kelton

Admit that the real economy is powerless against a de-regulated and de-supervised financial system
Recognize that the fiscal powers of the federal government can restore stability
Ignore the debt-to-GDP ratio; allow it to drift to whatever value is consistent with an economic recovery and a return to high employment
Enact a full payroll tax holiday by setting employer and employee FICA contributions to zero
Provide $1,000 per resident to state governments to help them stabilize projected budget shortfalls
Commit $2.5 trillion to restore our nation’s crumbling infrastructure and build a modern energy superhighway to facilitate expanded use of renewable energy, reduce greenhouse gas emissions and lessen our dependence on fossil fuels
Downsize the financial system; reduce the size of banks to the point that they no longer pose systemic risk
Ban the securitization of non-prime loans
Determine the real worth of bank assets; instruct the U.S. Treasury to conduct a survey of the underlying loan tapes and require banks to aggressively mark-to-market
Stabilize the housing market by creating a Home Owners’ Loan Corporation and bestow upon it a full range of powers, including renegotiation and rental-conversions, as deemed appropriate in each case
Announce a job guarantee program (like the WPA) to provide employment and income to the millions of Americans who will not find jobs in the private sector even after the economy recovers
Carry these messages to elected officials and urge them to practice these principles in all our affairs

8 Comments

Posted in Stephanie Kelton, Uncategorized

Tagged Stephanie Kelton

The Carnage Continues: Time To Ramp Up the Stimulus

Posted on July 7, 2009 by admin | 5 comments

By L. Randall Wray

Some like to see green shoots everywhere, but that is becoming an increasingly audacious hope. Here are four related stories from the July 5th edition of the New York Times:

Tax Bill Appeals Take Rising Toll on Governments By JACK HEALY

Homeowners across the country are challenging their property tax bills in droves as the value of their homes drop, threatening local governments with another big drain on their budgets…. The tax appeals and reassessments present a new budget nightmare for governments. In a survey conducted by the National Association of Counties, 76 percent of large counties said that falling property tax revenue was significantly affecting their budgets…. Officials in some states say their property tax revenue is falling for the first time since World War II.

Safety Net Is Fraying for the Very Poor By ERIK ECKHOLM

Government “safety net” programs like Social Security and food stamps have pulled growing numbers of Americans out of poverty since the mid-1990s. But even before the current recession, these programs were providing less help to the most desperately poor, mainly nonworking families with children… The recession is expected to raise poverty rates, economists agree, although the impact is being softened by the federal stimulus package adopted this year…. “It’s a good thing we have the stimulus package,” Mr. {Arloc} Sherman said. “But what happens to the most vulnerable families in two years, when most of the provisions expire?”

Employment Report Sours the Market By JEFF SOMMER

A grim report on unemployment on Thursday let the air out of the stock market…. In a monthly report, the Labor Department said that 467,000 jobs were lost in June. In surveys, most economists expected 100,000 fewer jobs lost. The unemployment rate edged up to 9.5 percent from 9.4 percent the previous month, to its highest level in 26 years, and virtually all analysts expect joblessness to mount in the coming months.

So Many Foreclosures, So Little Logic By GRETCHEN MORGENSON

LAST week, the stock market tumbled on news that housing foreclosures and delinquencies rose again in the first quarter. The Office of the Comptroller of the Currency said that among the 34 million loans it tracks, foreclosures in progress rose 22 percent, to 844,389. That figure was 73 percent higher than in the same period last year…. But the most fascinating, and frightening, figures in the data detail how much money is lost when foreclosed homes are sold. In June, the data show almost 32,000 liquidation sales; the average loss on those was 64.7 percent of the original loan balance.

What do these reports have in common? They provide powerful evidence that the federal government is not doing enough to help the “real” economy. As Sam Gompers famously responded when asked what workers wanted–“More!”—our nation’s state and local governments, households, workers, and poor need more help, now. We have tried the Reagan/Paulson/Rubin/Geithner “trickle down” approach of targeting relief to Wall Street, but the only thing trickling down is misery. The only way to stop the downward spiral is to substitute trickle-up policy—and even if nothing trickles-up, at least we will have helped those most in need.

I have already outlined a comprehensive recovery package so will here simply summarize four policies that would bring immediate relief.

1. Payroll tax holiday: This provides nearly $2500 of tax relief per year for each worker, with the same amount of relief going to that worker’s employer. The total stimulus to the economy would be somewhere around $650 billion per year. The relief is well-targeted (to workers and employers), immediate (take home pay rises as soon as the holiday takes effect), simple to administrate, and can be phased out (if desired) after the economy recovers.

2. State and local government assistance: The current stimulus package provided some relief to state and local governments, but was so little that it is forcing them to make Hobson’s choices: cut poor children from Medicaid roles or decimate universities? Furloughs for firefighters or postpone bridge repairs? Increase real estate taxes or raise fees for services? Only the federal government can resolve revenue shortfalls by providing funding to keep state and local governments running. Perhaps $400 billion, allocated by population (a bit over $1200 per capita) across state and local governments would be sufficient. If President Obama really could reform healthcare, that would generate tremendous savings for state governments that are saddled with exploding Medicaid costs to cover low income and elderly patients. Until then, direct grants are required. As I have argued, for the long-term we need a permanent program of federal transfers to states, with some of that attached to a requirement that they reduce reliance on regressive taxes.

3. Jobs to reduce poverty: Last week Pavlina Tcherneva provided an excellent argument for direct job creation by the federal government. We have already lost 6 million jobs, and Tcherneva notes that unemployed plus discouraged workers total about twice that number. However, a plausible case can be made that we are short more than 20 million jobs—as Marc Andre Pigeon and I demonstrated a decade ago. Further, as Stephanie Kelton and I showed, a substantial amount of America’s poverty problem is really a jobless problem. We found that in 2002 the poverty rate of families with no member working reached nearly 26%; on the other hand, if the family had at least one member working full-time, the poverty rate fell to just 3.5%. Our conclusions were similar to those offered by Hyman Minsky: “The achievement and sustaining of tight full employment could do almost all of the job of eliminating poverty” (1968, p. 329); “a large portion of those living in poverty and an even larger portion of those living close to poverty do so because of the meager income they receive from work” (p. 328). Minsky believed that “a suggestion of real merit is that the government become an employer of last resort” (1968, p. 338). Thus, not only will direct job creation reverse the trend toward ever-higher unemployment rates, but it will also go a long way toward filling the growing holes in the social safety net.

4. Homeowner relief: The plan offered by Warren Mosler provides an alternative to the current painful foreclosure process. When banks begin to foreclose, the government would step in to purchase the property at the lower of market price or outstanding mortgage balance. Of course, establishing market price in a glut is not simple and I will leave it to real estate market experts to compose a plan. What is more important is to keep people in their homes. Mosler proposes that the federal government would rent homes back to the dispossessed owners (Dean Baker has a similar plan) for a specified period (perhaps two years) at fair market rent. At the end of that period, the government would sell the home, with the occupant having the right of first refusal to buy it. By itself, this proposal would do little to stop spiraling delinquencies and foreclosures, and home prices will probably continue to decline for many months (or even years). However, as the other parts of this stimulus package begin to spur recovery, the real estate sector freefall will (eventually) be halted. I am somewhat ambivalent about continued falling house prices—on one hand, this will make housing more affordable; on the other it is devastating for families. Still, reducing evictions by offering a rental alternative will help reduce the pain of foreclosure. It might also allow the process to speed up (with smaller losses for banks) since many families would choose to stay-on as renters, with the possibility that they could later buy their homes at more reasonable prices.

I will not address here the preposterous argument that failure of the economy to swiftly recover is evidence against the Keynesian belief that government spending is the answer. Leaving to the side the Wall Street bail-outs (that do little to stimulate production and jobs), only a small portion of the stimulus package has been spent to date. There is evidence, however, that the automatic stabilizers (falling federal tax revenue and rising federal spending) are doing some good already—and would eventually pull the economy out of this depression. However, there is no reason to wait for our ship to hit bottom before it slowly resurfaces. Active, discretionary, targeted policy can reduce suffering and generate the forces that will be required to overcome substantial headwinds created by the private sector as well as by our state and local governments. Only the federal government has the fiscal wherewithal to lead us out.