bchadwick Wrote: ------------------------------------------------------- > Yep, it’s CFA Level 1 Econ. You have the solution then we should just sign all politicians up for CFA level 1. 
Dwight Wrote: ------------------------------------------------------- > If rearranged we can see that these sectors must > net to zero: (I – S) + (G – T) + (X – M) = 0 I don’t see how this necessarily leads to “the private sector cannot save without government deficits”.
jbaldyga Wrote: ------------------------------------------------------- > Dwight Wrote: > -------------------------------------------------- > ----- > > > If rearranged we can see that these sectors > must > > net to zero: (I – S) + (G – T) + (X – M) = 0 > > I don’t see how this necessarily leads to “the > private sector cannot save without government > deficits”. You caught an error in the sense that I was assuming a closed economy (no exports or imports). However it is a small error because the US has not run a trade surplus in decades and does not appear likely to. The rest of the world wants to accumulate dollars and in order to do so they keep their currency undervalued relative to the dollar. Think of it in terms of if you have 2 people on a desert island, one is called government and one is citizen. The government spends money but runs a “balanced budget” so it spends $100 every year and also taxes $100 every year from the single citizen. It is clear the government will never run up any debt in this situation, however neither will the citizen be able to save, because all of his income is going to taxes. Now assume the government decides to spend $120 while keeping taxes at $100. The government gives $120 to the citizen, and then at the end of the year, the citizen must pay $100 back. The net is that the citizen is able to save $20 which is then a claim on the government for future services. The way this plays out in real life is that when the government is running a large surplus (like in the 1990s or in the 1920s before the Great Depression) it means the private sector is piling on large debts on net. This would not be a problem if it were wealthy people borrowing against their savings, but it is the poor who have to borrow to finance consumption. This debt binge if it goes on long enough typically the debt fuels a private sector bubble of some sort and there is eventually a “Minsky moment” where the ponzi schemes collapse. If you look at the great financial crises in history they were all preceded by government surpluses and offsetting private sector leveraging. We are in a deleveraging cycle right now with people on net paying off or refinancing existing debts and saving more (7% savings rates) rather than spending. In order for this to be the case, there must mathematically be an offsetting government deficit, and not surprisingly, there is
Note also the parallels going on in Europe. Both Spain and Ireland ran budget surpluses prior to the financial crisis, and also coincidentally (?) had large housing bubbles. In addition, it is clear from the equations laid out above that austerity will not work in the Euro Zone because the gov’ts are trying to save while simultaneously the private sector is trying to as well, while the countries are not competitive enough to run a trade surplus. Rather than either being able to save, the economies just contract, which makes both worse off - the so called “paradox of thrift”.
so if there are only 2 private citizens on earth, there can be no saving?
jbaldyga Wrote: ------------------------------------------------------- > so if there are only 2 private citizens on earth, > there can be no saving? Sure there can. If one owes the other, then the other is “saving”. The point is that both cannot save simultaneously. My naming convention of calling one person “citizen” and the other “government” is just for illustration purposes.
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In economic theory, the private sector can only save “on net” if there is someone to lend to. If the private sector only lends to itself, then it is not saving on net. If it is lending to someone else, the only choices are to the government or to foreigners. One should add that in this model is not really lending, but lending+investing. Debt is basically investing at the lower end of the risk scale. So if we ignore the effect of foreign borrowing/investing for the moment, the only way to have the private sector save on net is to have the government as the net borrower. One can ask, why is that important? Maybe it’s more important that the government not borrow than for the private sector to save. But these are unusual times. US balance sheets (particularly consumers) are full of debt, especially in the mortgage sector, which is actually larger than the US treasury sector. In order to pay it down, consumers and businesses need to save on net, which means that either foreigners or the government must borrow from them. There is a strange set of opposing forces here. On the one hand, government borrowing should help stimulate additional saving; on the other hand, the expansion of the money supply is keeping rates low, and making savings unattractive. I think the way this is balanced is that, in a situation like this, people with the ability to save and who are indebted see a greater NPV in paying down debt as opposed to buying treasuries (because of low interest rates). The challenge is that many people with debt are precisely the people unable to pay it, because of the lending practices of the last 15 years. My brain hurts trying to think about this again…
I think this type of top down analysis is dangerous and policies based on them often create perverse incentives and only exacerbate the problem. but that’s just me.
jbaldyga Wrote: ------------------------------------------------------- > I think this type of top down analysis is > dangerous and policies based on them often create > perverse incentives and only exacerbate the > problem. but that’s just me. I disagree. What we are talking about is an understanding of double-entry accounting. How is knowing more about the way wealth is created “dangerous”? What is dangerous is that many citizens and politicians simply think “debt is bad” and therefore they vote to get rid of government debt, without understanding that the implication of that is that they are simultaneously voting away their savings at the same time.
bchadwick Wrote: ------------------------------------------------------- > There is a strange set of opposing forces here. > On the one hand, government borrowing should help > stimulate additional saving; on the other hand, > the expansion of the money supply is keeping rates > low, and making savings unattractive. > > I think the way this is balanced is that, in a > situation like this, people with the ability to > save and who are indebted see a greater NPV in > paying down debt as opposed to buying treasuries > (because of low interest rates). > > The challenge is that many people with debt are > precisely the people unable to pay it, because of > the lending practices of the last 15 years. > > My brain hurts trying to think about this again… I agree. I feel that it is more effective to think of the situation in terms of “balances” as opposed to “good” and “bad”. In psychology, this is referred to as “fundamental attribution error”. I.e. we see something happening and attribute the action to the internal characteristics of a person rather than the external situation. For example: “these people were greedy and should never have borrowed so much to buy too large of a house”, “the Greeks, Spanish, Irish, and Italians are all lazy and spendthrift while the Germans are hard working and thrifty.” These statements are erroneous in the sense that they misattribute the cause of the problem to the character of the person or country involved rather than to the circumstances surrounding them. The other side of this error is that when we are evaluating ourselves we do the opposite and consistently identify outside factors as the cause of our events. We would say “I can’t get a job because the economy is bad right now” rather than “I am unskilled and unemployable”. So the attribution error tends to cut both ways. Everyone always seems to want to save. The problem is that paradoxically no one can without someone else willing to go into debt. In my view, governments and corporations are far better entities to go into debt than households under normal circumstances. As households desire to save and pay down debt right now, even though interest rates are low, the best course of action is for the government to run a deficit in order to enable them to do so. In fact I think the deficit is too small as evidenced by 16m people who want to work and are not able to find jobs. The other point is that the debt will go away as the economy grows. Debt/GDP after WWII was 110%ish of GDP or around $300b. The newspaper articles during that time period were saying the same thing then as they are saying today “we are bankrupting our CHILDREN and GRANDCHILDREN”! We have a $14 Trillion economy now. When is the last time anyone called up their grandparents and complained about the $300b in debt they left us from that time period? In fact, the spending resulted in tremendous savings by the private sector which fueled the resulting multi-decade boom following the Great Depression.
True… Though one of the assumptions is that no one would save if interest rates are zero. Right? Keeping money under your matress is effectively saving, but no one is actually borrowing. And we know that some people actually do this. And in a deflationary economy, this can actually be a good thing (though generally holding treasurys or something else will pay even more. The second thing is that the savings equation doesn’t really link up with changes in the money supply. We could print up a bunch of money, and then use it to pay down the debt, and that would likely cause inflation, but not necessarily ongoing inflation. Or we could just accept that a bunch of debt is going to default and write it down, which would cause deflation and make credit so expensive that it would be hard to expand.
No, there is no problem if people want to keep savings with interest rates at zero. In fact this is essentially the case with modern day Japan. Interest rates are near zero because debt/savings levels are so high. There is not much to support higher interest rates because growth comes from inccreasingly productive private sector activity which is driven by demand/spending. The Japanese can theoretically save an infinite amount of claims against their government at a 0% interest rate. To get the money under your mattress in the first place someone had to spend a deficit. This goes back to the two person economy example: the government must first spend money THEN tax, because otherwise the citizen has no dollars with which to pay. Inflation is too many dollars chasing too few goods and services. Generally it happens when the government and private sector are both trying to spend more than there is productive economic capacity available in the economy. If one or the other is willing to save, the other can deficit spend and vice versa. The savings equation does link up with the money supply. You or I cannot create money out of thin air. The only entity that can do this is the government by deficit spending which creates additional deposits in the private sector. Operationally when the Treasury spends money it simply creates deposits out of nowhere by typing in numbers to a computer which go into someone’s bank account. If the government continued to deficit spend without issuing any more bonds, the excess reserves in the system would chase returns and eventually drive interest rates to zero across the treasury yield curve. Theoretically then people would have more incentive to spend rather than save, which could result in inflation. The fed more or less buys and sells bonds from the private sector in order to “mop up” excess liquidity and retain its target interest rate based on how much spending or saving it wants to induce. Now, certainly the economy does not always respond perfectly to interest rate changes (i.e. “pushing on a string”), which is why fiscal policy is generally regarded as a more effective tool for countercyclical government actions.
Dwight Wrote: ------------------------------------------------------- > jbaldyga Wrote: > -------------------------------------------------- > ----- > > I think this type of top down analysis is > > dangerous and policies based on them often > create > > perverse incentives and only exacerbate the > > problem. but that’s just me. > > I disagree. What we are talking about is an > understanding of double-entry accounting. How is > knowing more about the way wealth is created > “dangerous”? > > What is dangerous is that many citizens and > politicians simply think “debt is bad” and > therefore they vote to get rid of government debt, > without understanding that the implication of that > is that they are simultaneously voting away their > savings at the same time. if i misinterpreted your posts thus far then i apologize, but the general feeling i got from them is that the correct course of action today is for the government to continue to run and/or expand deficits to create the demand necessary to move the economy back to sustainable growth. i disagreee. we appear to be on opposite sides of the supply/demand equation. I don’t think I’ve met someone who has been convinced by another’s argument to change sides, so I’ll stop here.
^ That is fine, though I believe I actually agree with you more than you think I do. Often written comments can come across the wrong way and I am hoping to simply share a different perspective on a fundamentally difficult issue. All else equal, I would much prefer the private sector to be spending consistently and saving some on net as well, with the government running an offsetting deficit of say 3% of GDP into perpetuity, which would result in net gov’t debt staying constant due to the growth of the economy and allow the money supply to grow with the demand for it. This way, economic growth could occur because we would know what activities are “valuable” because people are spending money on them and then allocate resources easily to those activities through free market interactions. The problem is that the private sector has a lot of debt right now and really does not want to spend. Everyone wants to save. In that situation, we can either let the economy contract or the government can make up for the lost demand by either lowering taxes, increasing spending, or both. What I am talking about is the optimal response to a difficult situation, not an ideal situation in the first place.
Dwight Wrote: ------------------------------------------------------- > > > > The savings equation does link up with the money > supply. You or I cannot create money out of thin > air. The only entity that can do this is the > government by deficit spending which creates > additional deposits in the private sector. > Operationally when the Treasury spends money it > simply creates deposits out of nowhere by typing > in numbers to a computer which go into someone’s > bank account. > I think we actually agree that fiscal policy is really the key tool for our current situation (which makes us a minority on this board). I agree that the quote above is *generally* how money gets created, and that doing so requires a certain level of Treasury issuance and therefore debt. However, it’s not the only way that money can be created. The fed could basically buy a bunch of mortgages and then adjust them (down to zero)… ok, they might need a change in legal authorities to do that, but there might be something similar that they can do that doesn’t require it. This would effectively create money in the money supply, because a bunch of banks got paid dollars for stuff that was worthless, and now the money can’t really be withdrawn from the system. It would also change the system. I really want to find some time to think this part through, because although central banks are similar to ordinary banks, the fact that they have seignorage rights really does make them have a different set of rules. We don’t generally talk about this different set of rules (other than their “right” to set interest rates), because it’s a bit like discussing that Granny is a former Axe Murderer… if you don’t mention it, maybe she won’t do it again. But the economy is in the crapper and most of the traditional tools are either topped out or aren’t working, and maybe Granny is going to do some unconventional stuff.
ok one more: i think the optimal response is to let the imbalances correct themselves, take the pain now (losses on bad private/quasi private debt) and save greater pain down the road. i think we’re getting dangerously close to the time where “down the road” is here. The government can only take advantage of the USD world reserve currency status for so long and history has proven that perpetually inching down the road of currency debasement never works out. I worry that our political system has become so dysfunctional that gettting off this road is impossible. Even if we do make it out this time, government/Fed actions to take bad debt off of private balance sheets and put it on their own only enforces a perpetual put option in favor of the private sector taking excess risks. A more sinister view would suggest that politicians like this situation because they can use serial crises to enact “emergency measures” that tighen their grip on the economy and expand their own power, but I digress.
bchadwick Wrote: ------------------------------------------------------- > The fed could basically buy a bunch of mortgages > and then adjust them (down to zero)… ok, they > might need a change in legal authorities to do > that, but there might be something similar that > they can do that doesn’t require it. This would > effectively create money in the money supply, > because a bunch of banks got paid dollars for > stuff that was worthless, and now the money can’t > really be withdrawn from the system. It would > also change the system. Love the Granny analogy. I’m going to have to use that sometime soon. While the Fed and the Treasury are technically separate entities. I’m inclined to consider them as operationally the same. They are just separated in order to give the appearance of an independent agency, but when push comes to shove Guiethner has authority over Bernanke legally. Mortgages are loans to someone else. A bank holds a mortgage, someone else owes that money. The net is zero whether the value changes or not. If the Fed buys the mortgage, then it adds money on net to the system by creating a deposit in the bank’s account. If they then extinguish the obligation of the borrower, then by definition that is deficit spending since they have no asset to offset the liability they have incurred. Your example just shifts the deficits from the Treasury to the Fed.
jbaldyga Wrote: ------------------------------------------------------- > i think the optimal response is to let the > imbalances correct themselves, take the pain now > (losses on bad private/quasi private debt) and > save greater pain down the road. Agreed, and we are doing that. But that is only possible with a growing economy. Debts get worse if the economy is contracting. In order to pay down and take the losses on private debt, public finances (or net exports) have to be in deficit. i think we’re > getting dangerously close to the time where “down > the road” is here. The government can only take > advantage of the USD world reserve currency status > for so long and history has proven that > perpetually inching down the road of currency > debasement never works out. I worry that our > political system has become so dysfunctional that > gettting off this road is impossible. We 100% agree that the political system is dysfunctional In fact my argument is that both parties are “wrong” and are manufacturing a crisis in order to take the focus off of how bad a job they are doing at managing the economy. We are not “taking advantage” of the world reserve currency status. The US is the largest safest economy so it just is the world reserve currency. In fact, other countries are “taking advantage” of the US by keeping their currencies artifically unndervalued by buying up a bunch of USTs like China has done. This keeps their citizens employed and gives us cheaper products but it also removes demand that we need here. > Even if we do make it out this time, > government/Fed actions to take bad debt off of > private balance sheets and put it on their own > only enforces a perpetual put option in favor of > the private sector taking excess risks. A more > sinister view would suggest that politicians like > this situation because they can use serial crises > to enact “emergency measures” that tighen their > grip on the economy and expand their own power, > but I digress. True, no disagreement on TBTF or the agency problems with the finances in the private sector. Everyone loves a private sector bubble while it is inflating (1990’s through 2007) because we all feel richer. We’ll make it out eventually because economies tend to grow. But in the meantime there will be a lot of finger pointing and wasted productive capacity that is lost forever because politicians need to get re-elected.
Awesome thread.