Mosler: The wrong standard

January 19, 2010

Reader Note: This is the second entry from Warren Mosler in a debate with Jim Rickards about how to fix the economy. More on the authors here. This is a response to Rickards first piece. Mosler’s first piece is here.

by Warren Mosler

Jim’s recommendations are “sound money, lower taxes, and light regulation.”

We do agree on lower taxes. My proposals include a full payroll tax holiday to support demand. And while Jim suggests a return to Glass-Steagall, my banking proposals are even more narrow and dramatically reduce the need for regulation.  I also support price stability.

We also agree that the Monetarist concept of “velocity” is flawed, but our reasons differ. Jim’s derive from the long-dead gold standard where velocity is a calculation of how many times the given amount of money (gold) is used to buy and sell goods and services. Today, however, monetary expansion has nothing to do with money supply like it used to under the gold standard. The reason banks aren’t lending isn’t because they don’t have money to lend. Lending is constrained only by bank capital and the creditworthiness of willing borrowers, not by gold or any other concept of bank reserves. That’s why quantitative easing – i.e. the Fed printing money to buy securities – has no effect on bank lending.

Interest rate cuts transfer income from savers to banks, reducing overall spending. So while interest on savings dropped from over 5% to near 0%, borrower’s rates fell little if any. The wide yield spread means banks’ profit margins widened.

New Keynesian thought is also flawed, because it too presumes gold standard constraints. Today government never actually has nor doesn’t have dollars, and spends, taxes, and borrows simply by changing numbers in bank accounts at the Fed.

When it comes to the dollar, the US government is the scorekeeper. Unlike the gold standard days, the government can’t run out of money. Nor is it dependent on China to fund spending.

Under the old gold standard, taxes and borrowing did fund spending. Today taxes function only to regulate aggregate demand and to control prices.  The federal deficit is merely the difference between the numbers changed upward when the government spends, and the numbers changed downward when it taxes. Taxes therefore function to regulate aggregate demand, not to raise revenue, per se. Tax cuts increase our spending power, tax hikes lower it.  This is indisputable operational fact, not theory or philosophy.

Jim’s general warning is that too much spending or monetary stimulus might lead us to cross a “critical threshold where diverse actors reject dollars in a cascading collapse.” But this only applies to fixed exchange rate regimes such as the gold standard, where a weak currency results in gold outflows.

Today the dollar is a non-convertible currency.  The exchange rate continually adjusts, always representing indifference levels with no gain or loss of gold reserves. I would note too that the U.S. is actively seeking to weaken the dollar vis-à-vis the Chinese yuan. Would Jim want the reverse?

Jim’s arguments are as good as gold.  However, we are not on a gold standard, so they don’t apply. Today’s monetary arrangements call for my solutions to restore output, employment, and price stability.



I have a data challenge for you, or anyone who supports the notion that near zero rates are lining the banks’ pockets.

How many publicly owned banks would expect to have a LOWER interest margin if rates were to increase? How does this compare to the number of banks that expect MORE margin if rates were to rise?

This data is disclosed in banks’ financial reporting, it just requires leg work to track it down. I am fairly confident in my opinion about how the numbers would work out (you can probably guess my position from the phrasing of this post), but I have not compiled such data myself.

Posted by Andrew | Report as abusive

Mosler’s argument is pretty good, and I agree with his conception of money as credit balances that can be adjusted at will by the Fed. The need for the Treasury to “borrow” money is a hold-over from the days of the gold standard–except that if the Treasury doesn’t appear to be borrowing money (and suffering the consequences thereof) then the game is up and money will lose its motivational force.

If I told you that we were going to play Monopoly with four other people, but that person with the thimble would have the ability to create money at will, would you still play? The scarcity of money may be a fiction, but it is a darn convenient fiction.

As one of the Hunt brothers put it “Money is just a way of keeping score.” In a game that is obviously rigged, no one will keep score.

So even if money can be created by the Fed and Treasury in whatever amount at their whim, it doesn’t mean that they *should* do so.

Posted by But What do I Know? | Report as abusive

“Taxes therefore function to regulate aggregate demand, not to raise revenue, per se.”

The issue of taxation is interesting only as it relates to the preserving or eroding the purchasing power of the after tax income. If the government raised the tax rate to 95%, yet somehow the purchasing power of all the non government entities remained what it was before the hike, who would care? The problem is that the government is the biggest consumer in the economy. The more it consumes without withdrawing the ability to consume from the other actors in the economy, the more the prices go up and that reduces the purchasing power for the rest of us (see inflation).

Posted by andrea | Report as abusive

Who is this joker Mosler anyway?

Posted by andrea | Report as abusive

“Today government never actually has nor doesn’t have dollars, and spends, taxes, and borrows simply by changing numbers in bank accounts at the Fed.”

Say it again! However, how the national economy does is on plain view to the entire world so the hand of the government is certainly subject to constraints even without the gold standard.

Perhaps the solution is to find aliens on the other side of the galaxy, explain to them that we are hopeless with money and ask them to create a new currency and control dispensing it on Earth. We send them inflation data, they send or don’t send money. In response to our question “but what is backing it?” They would respond “Trust us.” We couldn’t go there to check them out, so it would be the ultimate fiat currency. What would they get out of the deal? I’m working on that…

Posted by CB | Report as abusive

For non-financial readers, some slight confusion may be reduced if Mosler’s words are edited as follows:
“Tax cuts increase our [private] spending power, tax hikes lower it. This is indisputable operational fact, not theory or philosophy.
Jim’s general warning is that too much [Federal-level public] spending or monetary stimulus might lead us to cross a ‘critical threshold where diverse actors reject dollars in a cascading collapse.’”

Otherwise, Mosler’s argument is very straightforward, and an obvious outcome of ending the Gold Std in 1971. All policy gridlock revolves around two issues. Manage unemployment and let Fx rates float, OR use unemployment to manage Fx rates. Policy implementation, of course, is dictated according to which type of citizens receive equal representation.

Posted by Roger Erickson | Report as abusive

The Bloomberg piece alleging that stocks are cheap based on multiples of cash flow is a ridiculous argument. Many companies are reporting higher free cash flow despite huge declines in sales and earnings because (a) working capital is a source of cash flow as the business shrinks and (b) capital expenditures are slashed due to a lack of attractive investment opportunities. Neither of these is a good thing. By those criteria, the best way to boost cash flow is to liquidate the business.

Alcoa is one of the companies cited in the article for improvement in cash flow. In Q4 2009 it generated $761 million in free cash flow for the quarter. We’re supposed to be impressed by that. But Alcoa generated $1.302 billion in cash from reduced working capital (A/R + inventories – A/P), $395 million by cutting the cash contribution to its pension fund versus prior year, and $1.796 billion by cutting capex in half versus prior year. Those items add up to $3.493 billion in cash improvement versus the $761 million of free cash flow.

So in terms of cash from operations excluding changes in working capital, Alcoa actually had negative cash flow of $2.732 billion in Q4 09 versus Q4 08.

The improvements in working capital were solely a function of declining sales. Alcoa’s sales dropped 31.8% but its A/R was down only 18.8% inventories were down 28.1%. So despite generating cash from working capital, days of sales outstanding in inventory and A/R went up during the quarter.

The story will be similar for Caterpillar, another company cited in the Bloomberg piece, and for many other companies. To suggest investors should put the same kind of multiple on cash generated by liquidating part of the business as they should on actual cash profits is absurd.

Posted by DP | Report as abusive

Clearly and convincingly stated, Warren.

The point is that the government as currency issuer is not financially constrained as are currency users, who are revenue constrained in their spending. The government as currency issuer does not need to “fund” its spending through taxation (revenue) or debt the way that households and firms do as currency users. Therefore, the oft repeated analogy of government budgets and household budgets being the same is bogus.

Under the present non-convertible floating fx currency regime, the sovereign government is the monopoly currency provider. This is a prerogative granted by the US Constitution. It carries the corresponding responsibility to use this power to provide for the general welfare, in the words of Preamble. Government money creation is therefore a public utility.

The government has the power and responsibility not only to issue currency but also to issue the right amount of it — enough of it to create prosperity by balancing nominal aggregate demand with real output capacity to make maximum use of the nation’s resources for national prosperity and not overshooting or undershooting.

If the government overshoots this balance and nominal demand exceeds real output capacity, then inflation results. If the government undershoots, then recession and unemployment result. Achieving and maintaining balance requires putting automatic stabilizers in place and adjusting ad hoc as needed.

Posted by Tom Hickey | Report as abusive

Right on WARREN!

Who is this joker Mosler anyway?

Somebody who could just walk away and leave us to our demise but chooses to use his innovative knowledge to try and help!

Posted by Dave Begotka | Report as abusive

Andrea “If the government raised the tax rate to 95%, yet somehow the purchasing power of all the non government entities remained what it was before the hike, who would care? ”

Anyone that had a fixed rated debt payment?

Who is this joker, Andrea?

Posted by David | Report as abusive

I agree with Andrew’s comments regarding near zero interest rates not being as beneficial to banks balances sheets as popular federal monetary theory would have you believe. If the banks can offer ‘normal’ interest rates it increases the strength of their balance sheet as deposits initially increase and grow faster over time. A stronger US Dollar would also happen as foreign money would flow into treasuries and CDs. Finally, the baby boomer generation deserves the right to higher interest rates as they move toward retirement ie into less risky investments. Lets face it this age group has the highest net worth right now so higher interest rates would result in some serious stimulus via the trickle down effect.


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