Krugman: What to Do

More from Paul Krugman. This is from the New York Review of Books (there's much more in the original):

What to Do, by Paul Krugman, NY Review of Books: What the world needs right now is a rescue operation. The global credit system is in a state of paralysis, and a global slump is building momentum as I write this. Reform of the weaknesses that made this crisis possible is essential, but it can wait a little while. First, we need to deal with the clear and present danger. To do this, policymakers around the world need to do two things: get credit flowing again and prop up spending.

The first task is the harder of the two, but it must be done, and soon. Hardly a day goes by without news of some further disaster wreaked by the freezing up of credit. ...

Even if the rescue of the financial system starts to bring credit markets back to life, we'll still face a global slump that's gathering momentum. What should be done about that? The answer, almost surely, is good old Keynesian fiscal stimulus. ...

I believe not only that we're living in a new era of depression economics, but also that John Maynard Keynes—the economist who made sense of the Great Depression—is now more relevant than ever. Keynes concluded his masterwork, The General Theory of Employment, Interest and Money, with a famous disquisition on the importance of economic ideas: "Soon or late, it is ideas, not vested interests, which are dangerous for good or evil."

We can argue about whether that's always true, but in times like these, it definitely is. The quintessential economic sentence is supposed to be "There is no free lunch"; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work. The true scarcity in Keynes's world—and ours—was therefore not of resources, or even of virtue, but of understanding.

We will not achieve the understanding we need, however, unless we are willing to think clearly about our problems and to follow those thoughts wherever they lead. Some people say that our economic problems are structural, with no quick cure available; but I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men.

Comments

[ndk]

Wolf has already begun to wonder how many obsolete doctrines we really have. Let's see how long it takes Krugman to accomplish the same. I still don't detect a hint of doubt nor analysis as to whether a large fiscal deficit will really make matters better or worse. Even Keynes' own models do predict there are repercussions to running large fiscal deficits. They raise real interest rates, and now that nominal interest rates have hit the lower bound hard, that's a cost that can't be discounted at all.

It certainly isn't a valid explanation in Japan, but Japan had a very large trade surplus and high private savings rate. We already run a large trade deficit and our private savings rate is extremely low. Individuals and corporations are starving for the same capital. The important indicators, including some Krugman collected, are flashing danger.

It's impossible for us to just "print" money on a meaningful scale, because there are no assets we can buy that have a positive risk-adjusted yield. That precise reason is why banks are not willing to lend for anything, and have $600B sitting in excess reserves. The Fed's balance sheet is in tatters. The CDS bounty the markets have placed on the Treasury's head hit 60 and is climbing rapidly.

The loss of faith and trust in our government would be a loss far greater than even our economic system, which, according to Buiter and others, may already be dead.

We need debt liquidation, bankruptcy, and a fresh chance for growth.

[don]

What ndk said.
I think we should weigh the small probability of a Treasury default against the truly massive costs such an event would entail.
Krugman is silent on the large international imbalances. Brad Setser points to $2 trillion in China's foreign exchange reserves and guesses it is headed quickly to $3 trillion. A big fiscal stimulus, with no attention to CA leakages, might just expand the current international imbalances with little to show in the way of reduced U.S. unemployment. The international imbalances must be addressed.

[ndk]

What don said too. :D

One more important data point. Our debt-to-GDP is around 353%, though probably a fair deal higher now. We're waiting on fresh data that will be released in December. Japan's, at the peak of its bubble, was around 200%. This is an incredible crushing burden, likely beyond the Chandrasekhar limit of debt. Even if somehow all our bailouts are successful, and Krugman's right and I'm wrong, they will succeed only in leaving the debt pile much larger than it was before, and even more likely to collapse inward with greater force. Scary.

Because of what don mentioned, China would do very well to stimulate their domestic demand and finally let the yuan rise. That would put even more severe strains on U.S. debt loads, and China would take a large hit on the nominal value of their reserves. However, they would finally generate significant domestic demand, and we could again sell things to the rest of the world. We could earn our keep, and actually pay for what we consume. Unfortunately, they're doing just the opposite, and we're doing just the opposite too.

What really scares me, though? It's Krugman's statements that prudence is very dangerous, that we must act immediately with incredible force. Now, I certainly understand why in expectation-based models and with decay of the underlying real economy that is the case. If you have a preconception that we can fix this problem if we just borrow enough money, prudence is indeed dangerous. If you instead look at the models and ideas from which that preconception were derived, you might reconsider.

Krugman's not reconsidering; neither are Geithner nor Summers likely to do so, and it's a binary choice. We either go balls-deep or not at all, and these are true believers, no matter how badly the actions have failed thus far.

Here comes the ultimate test of our dogma, once again. Let's hope it doesn't end like Bernanke's Greek tragedy.

[ndk]

One last comment, on a more personal note. Krugman's something of a personal hero of mine for his brilliant work on international trade. He's a man who once argued eloquently against the Bush administration's slavish adherence to deep-seated beliefs and ignorance of evidence in favor of their own favored world-view. It's really sad to see him like this.

This is Krugman's troop surge. I have no idea whether it will win this battle -- though I suspect it won't. I do know that it only prolongs and worsens the war.

[gordon]

Prof. Krugman: "The true scarcity in Keynes's world—and ours—was therefore not of resources, or even of virtue, but of understanding".

Which is why Keynes addressed the problems of his day without deference to the conventional wisdom and with a clean sheet of paper.

Any why Prof. Krugman and other contemporary economists should do the same - and not with deference to Keynes. I suspect if somebody with a ouija board could contact the spirit of Keynes, the first thing he would say would be "First, throw my old book out of the window along with all the others. Think!".

[gaetano catelli]

as the general economy continues to deteriorate, so will the problems with mortgages, car sales and loans, student loans, and credit cards, thereby further undermining the financial system.

and so, there is much talk of what kind of fiscal stimulous will decelerate the current slowdown and hasten recovery. clearly, in times like these, the best stimulus is the fastest stimulus. that would be cutting the withholding on worker paychecks NOW.

nothing will put money in the hands of consumers faster. nothing will direct resources more in accord with actual supply and demand in the real economy (rather than windmills, bridges to nowhere, or using taxpayer money to zero-out write-downs by banks).

at first many workers will use their fatter paycheck to save and/or pay down debt, rather than consume. that's fine. increased worker savings and decreased consumer debt will support the financial system and restore lending much more efficently than any amount of emergency bailouts.

eventually, as paychecks continue to be fatter, workers will consume again. no other stimulus program will have as much bang for the buck as cutting withholding

[bob mcmanus]

Nah, we aren't ready yet for the brand spanking new pomo distributed economics.

Aristotle:"All politics is the struggle of the haves vs the have-nots." I know you kids think you're brilliant and free and all, but maturity will teach you that there aren't all that many new good ideas. Twitter does not a revolution make.

Keynes took some of what he knew from Malthus.

And what anyway? We got a gov't. It's gonna spend or not spend, re-regulate or not. Just saying it isn't a binary doesn't create your rainbow.

If the question is about how much to spend and on what to spend, well, duh.

[yamada]

As reverse wealth effect diffuses to real economy, people gradually forget the root cause of phenomenon, and get lost.

By going back to and by solving the root cause, the whole economy will be relieved.

In this meaning "Yamada Model" as follows is useful.

It doesn't prop the price of specific asset, but it reforms the balance sheet of those inflicted entities, without any public costs:

Bubble is caused by peoples’ expectation that the price of asset(real estate) will rise in future, with pouring high-powered money to the asset side of economic entities’ balance-sheet. So, to solve this problem, such asset bubble on economic entities’ balance-sheet must be gotten rid of, by the new system as below.
Though it may be seen contradictory, high-powered money enables to work this new system.

1. Every economic entities’(including banks) assets that caused the bubble(real estate or CDO et al) on balance sheet should be evaluated on mark to market basis by the authorization of a third party(maybe financial auditor), which brings about some insolvent(i.e. debt section surpasses asset section on balance sheet) economic entities..
2. FRB decide to write off a certain amount of the loans to the banks, which amount distributed to each bank according to the amount of each banks’ insolvency, calculated on 1.
3. Every bank that gets profit from written off should next legally enforced to, by using the profit from written off as original fund, write off its loans to its each debtor, according to the amount of insolvency of each debtor. If the bank is unable to use all the written off profit it earned, the remainder is taxed all and absorbed by tax authority.
4. Other economic entity that gets profit from the written off by the bank should next legally enforced to, by using the profit from the written off as original fund, write off its loan(or trade claim) to its each debtor, in proportion to the amount of insolvency of each debtor. If the economic entity is unable to use all profit it earned, the remainder is taxed all and absorbed by tax authority. These processes are to be repeated operationally(multiplier effect).
5. In consequence, the bubble portion of the targeted asset is extracted from the economy, and is transformed to tax.
6. The tax claims is finally assigned to FRB. It’s up to FRB how they dispose of their above claims, considering the situation of economy, of each bank and of each economic entity. Talking about the latter two, as a option the FRB should examine the possibility of the bank’s and economic entity’s turnaround, together with the other creditors, remaining desirable debt to the bank’s and economic entity(empirically it's ten to fifteen times annual earnings before interest, taxes, depreciation and amortization, known as EBITDA, of the economic entity), writing off the rest debt, with taking into account the value of disposable collateral(that do not accrue earnings), of guarantor and of consolidated basis.
7. Every write off must be supervised and traceable by centralized function of the system. So every write off must be executed through this function. Every write off may be done through this function, which exist on internet for access.
8. For cross-border. For each non-residential economic entity, the amount of write off should also be calculated in the same way as 4. , on the only cause from specific asset depreciation in the resident country. Economic entity that will be written off should next write off in the same booked currency. In case profit of the written off exists on the non-residential economic entities, it's taxed and absorbed by the foreign(=non-residential) government and handed over to the sovereign(=residential) government of the currency, based on treaty.
9. FRB should carefully watch the rate of the number of insolvent economic entities to the number of all economic entities in the US, when deciding the amount of the loans(trade claim) written off on 2.
10. To keep FRB’s balance sheet sound, it must be permitted for FRB to generate profit by printing dollars in order to cover write-offs loss. These printed greenbacks is stored to the safe forever(I come to know the journalization if FRB’s profit is generated by their printing dollars is quite irregular).
11. In case inflation expectation exists(not now), the system enables FRB to on one hand raise benchmark rate to cope with inflation expectation, on the other hand restructuring the balance sheets of economic entities.

For further details, please see the blog as below:

http://reversewealtheffect.blogspot.com/

[im1dc]

Professor Paul Krugman's thinking has risen to a higher plain of thinking than the rest of us.

Awesome

I'm ready to take notes.

The German concept of Zeitgeist is real and we are all spectators as PK leads the economic thread of it.

[bob mcmanus]

And the real general insight of Keynes is rarely articulated very well by economists, who tend toward a dry pragmatic language, and run from the Probability Treatise. I don't understand it at all myself. But it may be his most important work.

Uncertainty & Time & Expectations. The "Euthanasia of the Rentier". Keynes was, well ok not post-Modern, but much more Modern, in the Einstein Joyce Stravinsky Picasso etc sense, than the vast majority of our socio-politico-economic institutions, which may still be in the 18th century. Economy and politics as Newtonian billiard balls. Put the factors in and get the output. No observing minds to screw up the equations during the process.

They couldn't predict the bubble or the crash, because irrationalism can't be factors. So 19th century. Keynes took the irrational as his starting assumption. Uncertainty and its discontents.

Nah, we have not gotten smart yet enough to discard Keynes.

[ndk]

2. FRB decide to write off a certain amount of the loans to the banks, which amount distributed to each bank according to the amount of each banks’ insolvency, calculated on 1.

10. To keep FRB’s balance sheet sound, it must be permitted for FRB to generate profit by printing dollars in order to cover write-offs loss. These printed greenbacks is stored to the safe forever(I come to know the journalization if FRB’s profit is generated by their printing dollars is quite irregular).

I think you've got a good idea, yamada, but you've got a principle of money creation here wrong that unfortunately ruins the entire thing.

No FRB can profit by printing dollars. The Fed can profit in two ways, just like every other bank in the world: by earning a positive spread between its assets and its liabilities, or by getting a handout from the Treasury(e.g., from Taxpayers).

Every dollar is a liability of the Fed's, not an asset of the Fed's. Its assets were traditionally Treasuries, but they're not anymore. They're a pile of random collateral that ended up there through various rescue initiatives.

They used to profit by earning a positive spread between their zero-yield dollars and their positive-yielding T-bills. Not only do these T-bills now yield less than 0.1% in some cases, but the dollars now yield 0.65%, not 0%. The Fed is losing money every day on this spread, and that doesn't even factor in the trash it bought at overvalued prices.

It's already quite likely the Fed will go bust, and we can only prevent that through an enormously destabilizing bout of very high taxation or very high interest rates. You should read Sims' paper.

[Bruce Wilder]

ndk, I'm trying hard to follow your argument, and failing. You seem to be touching on relevant concerns, but the logic chain linking them is not apparent to me.

To my simple mind, deflation is an economic emergency of the first order, portending a threat to the financial system, high unemployment and general misery. Is Krugman wrong to point to that problem as an emergency? the emergency?

Deflation is pushing real interest rates thru the roof (for corporate America). If you are worried about real interest rates, shouldn't you be on the stop deflation band wagon?

[bob mcmanus]

"Some people say that our economic problems are structural, with no quick cure available"

Well, I'm a Structuralist, but there may be a quick cure. I'm listening.

It's about collective action and gov'ts. What is a gov't, what is it for, what can it do? Is a gov't only to work on the margins, to create conditions for individual initiative? Very 18th Century, that. Or are "we" the "gov't" working with it and thru with every daily action?

Want some new-think? Collective action has become necessarily international and sovereignty may be in the way. May be time to make labour as borderless as capital and the safety net an international right.

[calmo]

thought provoking metaphor ndk "This is Krugman's troop surge. I have no idea whether it will win this battle -- though I suspect it won't. I do know that it only prolongs and worsens the war" and so far that Iraqi surge has proved to be a successful promotion (by all accounts that need to see a success no matter how premature).[To reconsider a resurgence of ethnic fighting or cleansing is an instant strike down...similarly what makes it Krugman's surge? or your sadness, ours? ...or just about any dang thing...urgency precludes prudence]

But I have time for another metaphor (nearly a reconsideration): a bunch of mechanics with all that training, with all that history of maintaining vehicles, all that respect and authority from their community, now suddenly stumped by cars that won't go. Not one of them...presaging not only transportation problems but that hard earned respectability.

I could have used Garbage Collectors, but they are famously untrained and are beyond trifles like respectability.

Last thing:Even if somehow all our bailouts are successful, and Krugman's right and I'm wrong, they will succeed only in leaving the debt pile much larger than it was before, and even more likely to collapse inward with greater force. Scary. Castin prudence to the wind (not like this) has the merit (and I B no trader) of buying us (all of us) time and civility for at least a few months...if indeed things were as dire as they report. The crisis needs just the right amount of amplification, yes?...putting another light on the phrase "crisis management".

[Bruce Wilder]

A silly question: what book was Krugman reviewing?

[bob mcmanus]

ndk, you might do a little research into the history of national defaults. They aren't so bad at all, at least compared to some alternatives.

Or the complete destruction of many economies in WWII. Took a while, but Europe and Japan came out ok.

These things are to be avoided if possible of course, but don't worry that we are going to become Guatemala. Ain't gonna happen.

Singapore or Japan maybe but even that is unlikely.

[Bruce Wilder]

bob mcmanus: "don't worry that we are going to become Guatemala."

Within days of witnessing 46% of voters give the nod to John McCain, after 8 years of GWB, your optimism seems exaggerated.

[Walt]

Our debt-to-GDP is 353%? Are you posting from a future where US GDP has fallen 75%?

[bob mcmanus]

MT posts his stuff, but knzn is up again with a post about Obama's dire threats to partly finance the stimulus with spending cuts.

Thank goodness for Krugman and whatever influence he might have, because I worry about Obama and I really really fear many on his economic team.

The spending cuts don't make a lot of sense as economics, and certainly don't make sense as tactical politics in getting programs thru Congress, so I have to assume they are based either on prejudices of our President or bad theory in his economic team. Scarey.

[ndk]

ndk, I'm trying hard to follow your argument, and failing. You seem to be touching on relevant concerns, but the logic chain linking them is not apparent to me.

Deflation is pushing real interest rates thru the roof (for corporate America). If you are worried about real interest rates, shouldn't you be on the stop deflation band wagon?

Yes, and I am. I think this is the point of confusion. My concern is that Keynesian stimulus and our other interventions will not stop deflation, but will in fact worsen it by increasing the total debt load, the volume of current credit demand, and hence, because nominal rates have flatlined, real interest rates.

[ndk]

Our debt-to-GDP is 353%? Are you posting from a future where US GDP has fallen 75%?

No, Walt, the tragic present.

[mmckinl]

Saving Jobs ... We do this with "Medicare for All". Medicare for All would help re-capitalize business (especially manufacturing), school districts, state and local government, individual payers and the under and uninsured. The states could use any excess of savings for unemployment and pension funds. Overall this could save hundreds of thousands if not millions of jobs while putting money quickly and directly into the system in the most efficient, fairest way ... taking care of people's medical bills.

How do we help consumers and homeowners? Bankruptcy Reform, in particular, legalizing house price reductions in bankruptcy court could solve many foreclosures almost immediately. They are also necessary because so many mortgages have several owners with different " pieces" of the mortgage. Chris Dodd already proposed this but was rebuffed by the banking interests. Bankruptcy reform could also be extended to the "cramdown" of valuations on cars and credit cards. This bankruptcy will not be a giveaway but a severe chastisement for credit abuse. The 2005 Bankruptcy Act was a travesty of justice.

We need to clean up the banks. Throwing money into banks won't work. We need an FDR style Bank Holiday or what has been referred to as the Swedish Plan. That is we first examine the books of the banks then decide who is viable (solvent) and who isn't (insolvent). The solvent banks are given help if they need it and the insolvent banks are liquidated where the account holders are made whole and transfered to solvent institutions. The process we are trying now , the TARP Program, is just picking winners and losers without knowing what the real losses are in the banks that are helped. And indeed there is ample evidence that this TARP Program is being guided by politics and favoritism rather than for the best interest of the public.

We don't need to stimulus for the sake of stimulus, the economy needs restructuring.

[Tomislav Najdovski]

The last sentence and paragraph reminded me of Marx.
He says something like - paraphrase - "Resources are not limited, it is the human mind that is limited"...

[bob mcmanus]

And seeing the early inclinations of Obama & his team, and the depth of the crisis, and the wasteful unproductive stimulus so far, and hey, my own ignorance and incomprehension of the financial markets...has led me to adjust my position on deficit spending and quantitative easing.

It's important for Obama to succeed quickly. Let's heighten the contradictions. Pedal to the medal, baby, just how far can we go? Ten Trillion? Twenty? Fifty? Let's change the world, Barry. Do it January 21.

Can we buy back all of our long-term treasuries?

[Walt]

But that's not the relevant criterion. The relative criterion is US government debt to GDP, which is around 70%.

The dollar is a liability of the Fed only as an accounting notion. The Fed has certain limits on its ability to act (intentionally, since you don't want a quasi-governmental entity to run amok), but the US government can always create more money and give it to the Fed.

[Gegner]

While Mr. Krugman is correct, the only 'tool' left for the banks to work with to (temporarily) accomplish this goal is 'time'.

The 'thirty year' mortgage has already 'handicapped' a generation of borrowers by leaving insufficient time to accumulate funds for retirement or their kids education...so offering 60 or 90 year terms will only succeed in kicking our current problems (a little) farther down the road.

Until recently, you could get 5 year financing on a 4 year old car. Let's suppose they kick that up to ten or twelve years? Kids may fall for it but anyone that knows cars know they eventually turn into 'money pits' just like houses do as they age.

Now you find yourself in the regrettable position of having to borrow even more money to keep your 'asset' in operating condition.

Until the cost of repairs exceeds the cost of paying it off/trading it in.

Increasing terms to make products more affordable is an unworkable solution in the long term...and suicide even if attempted in the short term.

[ndk]

But that's not the relevant criterion. The relative criterion is US government debt to GDP, which is around 70%.

How is that not a relevant criterion, Walt? We all need to pay back our debts, not just the U.S. government. This is a measure of how much we've promised to ourselves and each other relative to our current productive capacity. We've made very, very large promises. Bankruptcy and default are destruction of some of those promises. Government bailouts and fiscal deficits are even more promises and claims on future production.

... but the US government can always create more money and give it to the Fed.

The USD we use today are liabilities of the Federal Reserve. It's printed on them. The U.S. Treasury can't create them.

To get dollars into the financial system, the Fed has to perform a repo or purchase something. The dollar creation you're referring to is usually the issuance of debt by the Treasury and monetization by the Fed. However, we've already done just that, only through the Fed's new interest-on-reserves program. Cash is basically equivalent to (and higher yielding than) T-bills up to 6 months right now, and we've just put very large dead excess reserves into the system.

That means leaves us two choices: take either credit risk, or term risk, and the Fed can certainly take losses on those risks. As far as the private lending system is concerned, they will almost certainly take a loss on any credit risk. As I said in my response to yamada, the Fed and Treasury can only create dollars at a loss right now.

They've already filled their balance sheet with $2.1 trillion of a potpourri of securities nobody else wanted. As Buiter pointed out, central banks can go bust, and yes it matters.

[bob mcmanus]

7:02 is all theoretical, since the politics is impossible, but I am curious or at least interested. So many are telling me not to worry about deficits or the treasury.

Read last night, Peter Teman?, on the gold standard in the twenties. Germany hyperinflated then Dawes, US & UK contracted, blah blah.

With such a market for treasuries, so many pegged currencies, everybody in deflation, what happens if Treasury/Fed go hyperinflation or bust? If, say China decides to dump T's, well, the Fed is swamping the market.

My idea is along the lines of, via coupling, the US reflating the entire world.

[Walt]

It's not relevant because the tax man is first in line for our money. A lot of that 353% is going to get written down. The government debt will not be.

And what are you talking about? The Treasury can print all the money they want, and print whatever they want on them. In fact, money in circulation is usually counted as a liability of the Treasury, not a liability of the Fed.

[bob mcmanus]

I read the Buiter.

I need some help here, thinking outside the box. All the smaller countries, including the UK are in deep trouble, and may not have the means or reserve currency to adequately fight deflation.

If a nation defaults (several methods), the usual consequence is devaluation and localized hyperinflation. (?) But the dollar is fully international, with many trillions of dollar instruments held overseas, and so the devaluation and inflation could be universal.

And that's what we want, isn't it?

[ndk]

It's not relevant because the tax man is first in line for our money. A lot of that 353% is going to get written down. The government debt will not be.

I completely agree, and that's why I want the bailouts and stimulus to stop. Of that 353%, about 35% is now issued by or guaranteed by the Feds (10t + 8.2t, respectively and roughly).

The Treasury can print all the money they want, and print whatever they want on them. In fact, money in circulation is usually counted as a liability of the Treasury, not a liability of the Fed.

Walt, the Fed clearly publishes that they're its liabilities. From Wikipedia:

The authority of the Federal Reserve Banks to issue notes comes from the Federal Reserve Act of 1913. Legally, they are liabilities of the Federal Reserve Banks and obligations of the United States government. Although not issued by the Treasury Department, Federal Reserve Notes carry the (engraved) signature of the Treasurer of the United States and the United States Secretary of the Treasury.

We could do away with our current currency, though, that's true. I actually think there's a possibility of that.

[MattYoung]

Read the comments, followed and following the links.

That debt to GDP ratio is a promise to reduce consumption or increase productivity.

I bet the message is reduce oil consumption.

[Walt]

But it's not a liability in the usual sense. You go to the Fed with your one dollar liability, and demand repayment, and what does the Fed give you? Another dollar. The Fed injects money by buying an asset, and paying money for it. Once you sell the asset, you can't go back to the Fed with your money, and demand your asset back. You're stuck with the money.

[ndk]

But it's not a liability in the usual sense. You go to the Fed with your one dollar liability, and demand repayment, and what does the Fed give you? Another dollar. The Fed injects money by buying an asset, and paying money for it. Once you sell the asset, you can't go back to the Fed with your money, and demand your asset back. You're stuck with the money.

Yes, that's true. But the dollar represents a fraction of a claim on the assets matching it. If those assets lose too much value, then we either have to recapitalize the Fed, which is probably not really feasible, or the currency collapses completely, which is bad. You should check out the Bad Luck scenarios in Sims' Paper, and hope we get a Rosy Scenario instead.

[Hank Roberts]

So explain something to me here.

I recall some of the big inflation years.

How do they correlate with this kind of thing? Is there a lag time between when the money's printed and when its value in the pocketbook drops so dramatically?

I was having lunch with old, old friends a couple of days ago and noticed when we split up the check that nobody worried about increments less than a five or ten dollar bill, and realized the dollar has already gone the way of the mill, the penny, the nickel, the dime, the quarter, the half-dollar .... it's just too small in value to bother with if it takes more than five seconds to worry about counting them carefully, compared to trading it off for a few minutes' more time spent with friends we don't see often enough.

[ndk]

How do they correlate with this kind of thing? Is there a lag time between when the money's printed and when its value in the pocketbook drops so dramatically?

Hank, that's a great question. All the money the Fed and Treasury have created would be extremely inflationary if this were a normal environment. But it's not: all that money that's being created is going into hiding. You might visualize a room full of money, but only a small part of it is circulating, blown by a small dust devil (the economy). The size of the cash hordes outside the circulation doesn't matter at all. It could be tiny, or it could be enormous, but it's just sitting there in stasis.

Now, that dust devil might begin to grow at some point, at which point it would very quickly whip up the rest of those dollars into a full blown cyclone, with lots of paper flying around at very high speeds.

Normally, to prevent that from getting too violent, the Fed would take some of the paper out of the breeze, reducing the pressure, which would slow the speed and reduce the amount of paper flying around.

The trouble is, the Fed removes that paper by selling off a bunch of its own holdings in exchange for the paper. If the things it's bought turn out to be a bunch of dodgy CDO's and aren't worth much, then it has nothing to sell, and it can't stop that violent circulation. This, too, would be a bad outcome.

[ndk]

If the things it's bought turn out to be a bunch of dodgy CDO's and aren't worth much, then it has nothing to sell, and it can't stop that violent circulation.

And for those of you who really want to go deep into our weird new alternative world, the Fed can now as an alternative crank up the interest it's willing to pay on deposits it receives, well beyond the Fed Funds Rate. That would take money out of circulation.

However, that would also only make the Fed's balance sheet grow gradually worse. It would become quite literally a Ponzi bank, where the interest on existing liabilities is serviced by creating more liabilities. It's unclear how much popcorn would be consumed by foreign observers.

[Walt]

I've read the Sim's paper. Which scenario are you worried about? Inflationary spiral? Deflationary spiral? You seem to be invoking both at once.

And what's so hard about recapitalizing the Fed? The Treasury gives some bonds to the Fed, which sells them, and retires the cash. The Treasury could reroute all new debt through the Fed until the necessary amount of money is destroyed.

[calmo]

bob in the box, have you switched coffee brands?
[cannot resist Garrison K: Are you feeling so stressed out even Senator McCain doesn't understand you?...you need ketchup bob. Replace that first cup of coffee in the morning with a cup of ketchup and you'll feel the difference.]

And congratulations for avoiding the crisis getting beyond Buiter's rubber hose and the basement (I knew there was somethin about his face, I knew it.)
To stuff Roubini's quip (not as reported by one of our comrades here as "clear and simple")
[about why the economists missed the housing bubble]
Roubini: "they were in the bubble" (which is neither clear nor simple but non-transparently bubblicious)

into that cliche (tis so bob, tis so inside the box, I'm hidin my head under a fry pan this very instant!)

bob: "I need some help here, thinking outside the box."

I only got inside the box help (it could be worse: inside the bubble help):

I used to think a distinguishing feature of the current crisis was not it's global nature, but that it is the senior currency in transition wibblewobble. And so the history of the UK's currency might be apropo (albeit sans the shadow banking system). But I cannot bring myself to view the only other contenders (the euro mostly) seriously.
It's too early.

[ndk]

Walt, I'm worried about both, just like he is. I think the deflationary spiral is more likely, and I believe the odds of falling into it are increased by this stimulus plan. I could very well be wrong, in which case the other scenario becomes an immediate strong concern.

The Treasury gives some bonds to the Fed, which sells them, and retires the cash. The Treasury could reroute all new debt through the Fed until the necessary amount of money is destroyed.

A) The Treasury can't just give bonds it issues to the Fed without wrecking its own balance sheet unless it dramatically increases taxation, which as Sims points out could be difficult due to the popular hatred of Wall Street and the Fed, or for economic reasons.
B) If the Fed sells bonds, it has created cash, not retired cash.

Issuing bonds, taxing corporations and individuals, and giving them to the Fed to hold would recapitalize the Fed via taxation, as I stated earlier.

[ndk]

Sorry, scratch B there. I misread you and it's getting late. My mistake.

[Walt]

No, if the Fed sells bonds, it removes cash. The Treasury gives the bonds to the Fed, which marks them as assets. It sells them, which takes the asset off the balance sheet, and uses it to extinguish the amount of circulating cash it has as a liability. The Treasury is a long way from wrecking its balance sheet -- debt to GDP is only around 70%.

If we get to spin out worst-case scenarios, then if the government follows your plan, we get 25% unemployment, violent revolution, and war with China.

I do have to say, though, that while I think your plan would destroy the world's political future, that I've found arguing it out with you rewarding.

[Walt]

Oops, I missed your retraction. No problem.

[ndk]

The Treasury is a long way from wrecking its balance sheet -- debt to GDP is only around 70%.

That's true, though it doesn't account for the large guarantees we've undertaken.

But there's the deeper question of what happens if these interventions succeed. Let's assume China and the rest of the world go back to their old growth watering hole of exports. That seems very likely: China's already increased export rebates, and it's made noises about devaluing its currency further. That funds our immediate cash crunch, makes exports more attractive for them, and it makes their domestic markets less appealing.

We end up with more consumption, worse trade imbalances, less competitive domestic production and investment, and even more debt. China ends up with less consumption, worse trade imbalances, and more credit that's unlikely to be repaid.

The real key to a benign outcome is convincing China and the rest of the world to quit their mercantilist practices. Hank Paulson, who is very tight with the Chinese, before all of this made many attempts in happier days to get them to change their ways. He repeatedly came home empty-handed. It's not clear at this point that China could change without bankrupting their own PBoC: they have foreign assets denominated in dollars, and domestic liabilities denominated in yuan. Write down those $2 trillion dollars by 30%, and... heh.

This is why I think they intended to inflate their way out of the problem in the first place, because then they can make up the losses through seigniorage.

Success here seems like as bad an outcome as failure.

I do have to say, though, that while I think your plan would destroy the world's political future, that I've found arguing it out with you rewarding.

The feeling's mutual on both counts. I don't hold my suggestion out as a benign outcome by any stretch of the imagination. I just think it's somewhat inevitable at this point and we may as well not make things even worse first.

Thanks for catching my mistake as well.

[Arthur James]

Afficionados of Paul Krugman's writings will recognise that this magnificent piece not only restates his belief in the importance of Keynes's economic insights, and of the need for fiscal stimulus today, but does here what he often does not - that is, emphasize the importance of a global, or at least international, approach to the current crisis.

He talks here of "the world" needing "a rescue operation", of what "policymakers around the world need to do", of the need for "a global rescue for developing countries", and of what must surely be an international response to the dangers he identifies in "financial globalization".

This, as some bloggers of Krugman's columns have tried to point out, is exactly the sort of cooperative international approach that Krugman's intellectual hero, John Maynard Keynes, took in his own time. This is evident in works on Keynes such as, for example, Markwell's John Maynard Keynes and International Relations.

Part of why it is important for Krugman to stress this international approach is that the United States today (or at least after 20 January 2009) needs to provide leadership in this cooperative international approach to the economic crisis - just as, Markwell points out, Keynes desperately wanted it to do at various times from 1919 to his own death in 1946.

The case must be made persuasively today for such US leadership - and Krugman can help to make it.

[Jim]

Or not. Possibly a transition to buying what is absolutely necessary is called for. That of course will mean the demise of most businesses extant.

[Walt]

I actually agree with the China bit. If the US stimulates through deficit spending, and everyone else stimulates by exporting to the US, then the US will have to inflate its way out of the situation.

[ndk]

I actually agree with the China bit. If the US stimulates through deficit spending, and everyone else stimulates by exporting to the US, then the US will have to inflate its way out of the situation.

Yeah, that would be the preference. But we've only fallen into deeper deflation despite lending, bailouts, stimulus programs thus far, and nearly doubling the monetary base. If I prove to be right in my guess that we're worsening deflation by raising real interest rates inadvertently...

Or if I'm wrong, and we do generate a lot of inflation, but the Fed lacks any ammo to fight with so we have to increase taxation dramatically, and this happens in the midst of running very large deficits importing key resources like oil...

I think I need a bucket to puke in.

[Walt]

All of your evidence fits Krugman's argument that we're in a liqudity trap, which makes monetary policy ineffective. Maybe Krugman's wrong, but I don't see why when he predicts that if a (liquidity trap) then b (monetary policy failure) will happen, and then the world provides him an example of a followed by b that he should be rethinking his world view.

[ndk]

then b (monetary policy failure) will happen, and then the world provides him an example of a followed by b that he should be rethinking his world view.

It's an if B, then C that I think he's missing.

If monetary policy can't be accommodative, because it's already failed, then fiscal deficits have a high likelihood of also becoming contractionary under Keynesianism, post-Keynesianism, monetarism, and classical economics. Japan has already demonstrated that in practice, even though their real interest rates actually fell(which I believe to be because they were running a current account surplus).

[ndk]

And also because they had high savings rates. We can see that even there, in those ideal circumstances for Keynesian stimulus, they never got out of the hole despite all their efforts and only ended up with a 195% debt-to-GDP ratio for their troubles.

I am sympathetic to the argument that it was too small, too late for them, but you can still see that their savings rate declined rapidly throughout the 1990's to no avail.

I'm not at all sympathetic to that argument here.

[Walt]

I skimmed that paper. Krugman would argue that if deficit spending doesn't cut it that the government should commit to directly causing inflation (presumably through the central bank buying debt from the government and paying for it in dollars, though I'm not sure he's proposed a specific mechanism). That's exactly what he argued in the case of Japan.

[ndk]

Krugman would argue that if deficit spending doesn't cut it that the government should commit to directly causing inflation

I suspect so, but there are very strong arguments why the only ways to do this are practically extremely difficult and extremely unpalatable politically and economically to boot. Krugman made 3 of them himself, but he stops short of mentioning the ruined Fed balance sheet, truncating it as The fed shouldn't take on risk. Given his visibility, I don't blame him.

[calmo]

How does the US consumer, not quite exhausted, get his mitts on the refreshment?
The $600/adult apparently was not the pilot program I thought it would become. [Had the administration only known the scale of the political ramifications, they might have been more generous, no? But sadly, they did not have competent economic advice, only tightwads...(and that is clear in hindsight now and everybody is for "generous", "bold")....]
Exactly how does the infusion move from the investment banks-to-troubled businesses...to the debt-ridden, jobless, homeless and hungry workers?...a growing and possibly uncivil segment, if it doesn't launch straight into The hungry mob.
The perception seems to be that consumers are not exhausted or exhausting, but waiting , sitting on cash, ready to spend...at the right price...igniting for some the somewhat academic deflation worry.
Norwegian Blues every last one...Beautiful Plumage!

Nobody has articulated this that I can see....so it must be the same old "trickle down"?
By Post Service?
Divine intervention maybe.

[Walt]

How is it practically extremely difficult? The Treasury starts selling 30-year bonds directly to the Fed. The Fed pays in money. The Treasury takes the money, and spends it on consumption goods.

[Oupoot]

Linking to a comment in an earlier post - what is the time lag between money supply and inflation/deflation? I know its old school (like 1970s & 80s) to think money supply & inflation, but is the current deflation in the US simply a by-product of the significant redution in money in circulation in Sept & Oct 08 before the Fed intervened dramatically? Or, that despite the massive liquidity injections by the Fed, the actual amount of money in circulation reduced due to less lending and more hoarding of cash (and cash equivalents) by private financial institutions? If this is the case, then we should expect that (hyper?) inflation will materialise with a 2 month lag once the credit system begins to operate more effectively again. And I agree with ndk, I dont think the Fed has the right type of assets to neutralise that threat quickly, i.e. just to reduce money in circulation, they may have to sell some assets at 30c to the $ or less back onto the market.

[ndk]

How is it practically extremely difficult? The Treasury starts selling 30-year bonds directly to the Fed. The Fed pays in money. The Treasury takes the money, and spends it on consumption goods.

The 30 year bond is already very strongly bid, yielding 3.45% (Japan is at 2.19%, and 20/30 yr inverted, WTF?); implied inflation via TIPS even at 20 years(the longest issuance) is 0.7%; the Treasury market is enormous, so any directly forced appreciation would require inconceivably large purchases; and if inflation does happen to reaccelerate during those 30 years, the Fed loses on its purchase and requires further recapitalization by Treasury.

Jim Hamilton has suggested the purchase of outstanding TIPS, which is less dangerous, if you're going to do this. That might make investors a wee bit nervous, though.

[ndk]

Oupoot,

Linking to a comment in an earlier post - what is the time lag between money supply and inflation/deflation?

Depends how efficient you think markets are. Fully rational and efficient markets should reprice themselves immediately upon receiving the new information. In folklore, the lag in response to interest rate changes is about 12-18 months. When it comes to quantitative easing and today's wacky world, I have no clue.

I dont think the Fed has the right type of assets to neutralise that threat quickly, i.e. just to reduce money in circulation, they may have to sell some assets at 30c to the $ or less back onto the market.

Well, they wouldn't have to sell per se, they'd just have to stop rolling over some repos. But you're right, that would probably have the unfortunate side effect of re-blowing up the banks.

[hari]

This discussion is useful - although *walt* and *ndk* don't use the term *political economy* - Paul's argument (now) goes *global* with macro-adjustment along with EU and emerging markets included.

Welcome PK - Laureate - finally!

I suppose he's got a glimpse of the discourse in BOs/NEC already....

Dr Dooms GRE briefings are now more than year old - since its issue - Paul's argument(s) have been discussed in detail by GRE contributors - their perspective always (repeat always!) takes into account globalized financial/trade markets.

Globalization is the cause of the current financial crisis. No amount of disjointed academic perspective can disregard the accumulated evidence to that effect.

First, US will have to undertake IMF style structural adjustment medicine and bring its household economy and book keeping in proper order - a daunting task at this stage!

Second, technicality on what's the fiscal impact of credit and money in the current circumstances (Soro's new book) gives adequate argument to revamp ways and means by which global currency hegemony is currently exercised by USD.

China, India and EU are going to force this agenda item next time.

Third, G-20 meeting next April (Lon) will enter into a long overdue process of realingment of international financial structure (Roggof/Reinhart) and its (independent) regulatory
regime.

This must finally become an independent global monitoring and regulatory regime to avoid another meltdown (like this).

[hari]

Correction - RGE Monitor (not GRE).

[Beezer]

Swirling money and dust devils. Whew. You folks have me confused and dazed.

A question. Several actually. If the entire globe is using our currency, are any of these debt to govt expenditures, or whatever, telling us anything important? What's the debt to global production, stated in dollars? Maybe the dollar is the only currency, in reality, and maybe all the globe's debts and production should be considered in total when discussing the dollar's health.

All other currencies are, in effect, a fiction because everything is being measured by dollar amounts.

[Beezer]

Maybe the question is.

What happens to another country's currency if IT becomes the world's language of global commerce. Just how many Chinese "dollars" can one purchase, or Indian "dollars" if the American dollar becomes worthless? What happens to those currencies under such an event, and what happens to their economies under such an event?

[yamada]

ndk,

What if "yamada model(or system)" is an exception of principle of money creation?

And what if the exception solves the entire problem, with "yamada model" operated under the rule as I aforementioned?

So, could you give me your further opinion on this point?

From now I would like to read "Sims' paper" following your advice.

[BJ Feng]

Didn't China just announce a near $600 billion domestic spending program? The yuan has appreciated against the dollar steadily, and since the dollar is stronger now against all major currencies, that means the yuan has appreciated significantly against everyone else too.

What would you have China do? Their domestic consumption can't generate enough demand, they are export focused because it works. The evidence is clear that JOB CREATION is the path out of poverty, make it attractive for businesses to open up and if they do, then your problems are solved. No government training programs, no increased welfare benefits, no unemployment insurance, no national health care system (China dismantled their "iron bowl" socialist system), none of that is necessary. All government has to do is build infrastructure to allow businesses to move their products quickly and efficiently and the populace becomes wealthy thanks to the jobs provided by private sector firms.

Eventually people will become wealthy enough to demand and buy all the luxuries Americans take for granted. But cut off the export sector and the US still would be no better off, it's not if China receives 100% of the profits from the goods it manufactures. Think of the stuff made in China and where you buy it from. Whether it be an IPod, or a T-shirt from Walmart, China only makes a fraction of what the US firm gets, AMERICAN COMPANIES BENEFIT THE MOST! And consumers receive lower prices and can buy more, thus raising their standard of living.

The US has a huge trade deficit because Americans are getting a great deal. They give dollars which can be printed at will and receive tangible goods in return. The dollars that go out will be devalued in the future making the products imported even cheaper. Eliminate that trade and Americans will suffer, they'll be able to afford fewer clothes, fewer electronics, and the standard of living will decrease for all Americans, but especially the poor. America doesn't suffer from a lack of jobs, we are in a severe recession, but structurally, there is no job shortage in normal times. Besides, the jobs in the Chinese export sector are not good paying jobs.

The government should take a page out of China's playbook and spend money on infrastructure. The goal should be to increase efficiency and make it easier for people and goods to get around, not on ridiculous mass transit ideas that are inefficient and costly. Build more roads. Los Angeles should have all of its freeways double decked, that would create a huge number of jobs and generate even larger benefits in time saved and quality of life. What we need are unpolitical policies that generate the most amount of good, REGARDLESS of the political nature of the policy.

[ndk]

I got it. I found my transmission vector by which these actions would raise real interest rates. It's solvency fears. In a traditional IS/LM framework, you'd envision a liquidity trap as a flat line segment on the LM curve, which means shifting the IS curve to the right through more government investment is always a good thing. I think that's what Krugman is drawing on. But solvency fears change that completely.

I owe the realization to Krugman's brilliance, ironically, in his writings from 1999. Read section 5. I don't know why he's ignoring that now, when there are very obvious and rational fears about the government's solvency.

As fears of the solvency of the U.S. Treasury/Fed increase, real interest rates will rise too. It is, in effect, an additional risk premium being built into the pricing of all USD denominated assets out there. More spending in any form, bailouts, or purchase of assets at unrealistic prices will increase real interest rates. I had a discussion earlier about whether it was financial market turmoil or increased government borrowing that was causing real interest rates to rise, where I had no good answer. Now I do. The answer is, "yes."

It fits with everything, and I feel like an idiot for missing it sooner. Now it's time to sleep.

[yamada]

ndk,

I would like to add that the exception is permitted, because the value created by printing the greenback is nothing less than the people's expetation that the price of real estate would rise.

says...

Beazer, the currency system today is postmodern in that there are only relative values, not absolute values. Currencies are measured against each other, there is no fixed point of reference, all currencies are fiat and can be printed at will. I suppose all that matters is that we don't print MORE than others, it's a relative system where everyone is continuously increasing the amount of currency that is available.

That probably didn't address your question, but as the world's reserve, we must create enough dollars to satisfy world demand. That is unlike Russia, England, or Australia where they need to create only enough for their domestic (and a small international contingent) needs. The Euro is being held as an asset by other central banks, but this crisis shows that settlements are in dollars so dollars are what matters and what everyone needs to make good on their debts. That gives us a huge advantage as we can print dollars and "sell" them to other countries because they need them to settle transactions and use as money. If China or some other country grows, they need more money, they need more dollars. We then trade our dollars which we print for tangible goods, China then can use that money for transactions.

As long as the dollar remains the world's reserve, and the world's GDP grows, we can continue exchanging our dollars which cost nothing to produce (just the FED making an entry in a computer) for tangible products and intangible services. The dollar, like all currencies, cannot be redeemed, it can only be exchanged for other currencies. Should the demand for dollars fall, so will the value of the dollars in terms of other currencies, thus automatically canceling a large portion of our "debt". Sure our living standards will decrease, but mostly due to the inability of issuing our currency for goods. This is a debt that never has to be repaid (for the most part), if the dollar starts to lose value, our debt load decreases too. It's good deal for Americans and why Americans are so heavy into consumption.

[BJ Feng]

That was me above by the way.

[Beezer]

Roads are neither cheap nor efficient. They are like our water system with one important difference. It rains everyday. You build a road it fills up. You build a bigger road, it fills up. You pave over more and more soil. You disperse production facilities and force workers to travel farther and farther just to work. You create hugely expensive sprawl problems. Try moving around Boston, New York, Chicago, Washington, or even LA without trains. More fuel efficient cars. Sure. But more cars and roads? No. Our economic engine needs to start relying on other transportation more. We need to shrink, not expand, our reliance on trucks and automobiles.

Trains are more efficient. And they will provide an alternative to roads and cars. Something we need to have for security reasons alone.

[hari]

The twin problem facing policy makers is in order of priority (1) deflation and (2) inflation.

The global (financial) coupling is a gurantee that deflation will impact across the Atlantic and emerging markets. In ECB region deflation is now imminent, if not already done deal.

The rate at which Fed/ECB/CBs are pump-priming the credit markets is a sure sign they don't care (for now atleast!) about inflation. However, the evidence is accumulating and the impact will be severe when inflationary pressure finally catches on....

In sum, the text books tools which Fed/ECB/CBs are deploying are invariably from a different (global) macro setup. I'm not sure whether (or if) it will make a dent in the present circumstances.

[DD]

"Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work."

The free lunch is not automatically achieved. If the unemployed are tasked to dig ditches, and fill them in again, no additional goods/services are added to the economy. No useful goods/services have been gained, only redistribution of formerly extant goods/services.

The free lunch can only be obtained if the unemployed are tasked to produce something of real value to consumers (something they would willingly buy, if given a choice). Useless pork projects reduce the standard of living of the majority. They are not a free lunch, even now.

[Lee A. Arnold]

Am I wrong here in guessing that the "free lunch" is to "print the money?" Which is what we're going to do, because inflation isn't an issue? I.e., go "off-budget?" (one of my favorite terms, from the old S&L bailout.) And, nobody near it, wants to say it, because it's going to bail out all of their rich friends on Wall Street, i.e. what the rest of us refer to as "the assholes?"

[a]

"Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work. "

Yes, and that's a big "if". So aren't the stimulus supporters going at this as$-backwards, by saying we need a stimulus of 1 trillion dollars, without even figuring out first whether we can, or how to, use those unemployed resources, and how much it should cost? A lot of those unemployed resources will, I'm afraid, turn out to be basically costs and with little productive capacity, such as real estate agents who have no skills. Do we expect them to be teachers? Or construction workers? C'mon, can we be realistic for once, rather than pie-in-the-sky? Just once? Before blowing through a trillion, as if it were Monopoly rather than real money?

[Lee A. Arnold]

And, that's when we're being "polite?"

[Massimo GIANNINI]

Krugman is not making at all a convincing economic and logic case for a big and quick fiscal stimulus. His case is being mounted on a kind of self-fulfilling prophecy: if we do it, it will work and if it will work we must do it, now.
Perhaps it's better to ask Krugman What Not to do as it will cost less money.

[Barkley Rosser]

ndk,

Please stop worrying to death and threatening to puke. The greater danger would be a 1931 style meltdown due to a move to "liquidate debts" as you are calling for. We already saw the shutting down of Lehman Brothers creating a far worse mess and freeze up of markets than was expected.

Also, drop all the scare talk of 353%. Much of this is domestically owed credit card debts. Our foreign net debt is somewhere between 2 and 3 trillion dollars, less than 20% of GDP. This will probably rise another trillion, which is not pleasant, but looks a lot better than the alternatives. A lot of that constitutes an unpleasant chunk of the 70% of GDP that the US government national debt is.

Also, some of these "obligations" are actually obligations of other countries. Thus, about $700 billion of the new obligations of the Fed on its balance sheet are actually ECB debt taken over in swaps to help them out after the SIV market there collapsed and that junk came back onto the books of various major European banks.

So, become calmo.

[a]

"Also, drop all the scare talk of 353%. Much of this is domestically owed credit card debts. "

I don't see why this is scare talk. If the credit card debts can't be paid back, the banks are insolvent once more, and the government has to ride to the rescue by injecting more capital. For me, the relevant question is how much taxes the American taxpayer can afford in the future. If they owe credit card debt (or debt for college education, or auto loans), they can less afford higher future taxes, which are needed to pay for government debt. Japan can support its higher government debt, because its citizens save and so are able to support the higher future taxes which are implied by the debt. I'd love to be wrong about this; please convince me!

"Our foreign net debt is somewhere between 2 and 3 trillion dollars, less than 20% of GDP." I think there's a pretty large uncertainty exactly what the foreign net debt is. But surely it isn't just foreign net debt which determines the level of debt the nation, as a whole, can afford. Consider debt between Americans. If 1% of the U.S. are big creditors and the rest are big debtors, the nation can't afford a lot of debt, unless we go to a wealth tax. That isn't going to happen (or if it did happen, the wealthy would try to expatriate their wealth, and it would become unavailable).

[Walt]

ndk, if the Fed wants to achieve inflation directly, then they don't need to worry about the Treasury bond markets at all. The Treasury sells them to the Fed directly. Whatever the bond market wants to do is the bond market's problem. It's an accounting fiction. The Treasury could even issue the Fed special non-marketable securities, so that it really is purely an accounting entry at the Fed. If the US government wants to achieve an inflation rate of 2 percent (say), they can do it.

Anyway, given the totality of the fears you've expressed, it's clear what policy you should be advocating. The Fed should quantitatively ease by buying longer-maturity Treasuries. The big fears you've expressed are that we'll have deflation made worse by fiscal stimulus, or the Fed will overshoot and we'll have inflation which the Fed can't correct because it's balance sheet has deteriorated. If the Fed quantitively eases, and it doesn't work, then we're no worse off than if the Fed had done nothing (which is what you're advocating). Deflation will make the deleveraging process more difficult, so if the Fed does nothing, the the crisis will be worse than it would be otherwise. If the Fed overshoots and inflates too far, then the Fed's balance sheet is in great shape, because it holds lots of US Treasuries, which it can sell.

[Barkley Rosser]

ndk,

I was a victim of this darned typepad making you go to "more comments." Did not see your most recent remark.

How is that the "insolvency" that people are afraid of is US Treasury rather than private banks and insurance companies and so on? They have been failing like flies in the midst of a bug spraying campaign. Where have all the frightened sheep gone? Well, as anne has noted, US 90 T-bills are currently at 1 basis point. Does not look like any massive fear of US Treasury insolvency out there. Heck, it is the last resort for the frightened around the globe.

You are seriously off. Think of becoming calmo.

[a]

"Well, as anne has noted, US 90 T-bills are currently at 1 basis point. Does not look like any massive fear of US Treasury insolvency out there."

The markets are reasonably dysfunctional at the point, but even taking this at face value, it implies only that the market thinks the U.S. government won't go bankrupt in the next 3 months. I'd agree with that assessment. But look at 10-year credit-default swaps on the U.S. government (56 bips the last time I checked). That's not AAA.

[Bruce Wilder]

a: "So aren't the stimulus supporters going at this as$-backwards, by saying we need a stimulus of 1 trillion dollars, without even figuring out first whether we can, or how to, use those unemployed resources, and how much it should cost?"

No.

Another edition of simple answers to simple questions.

[save_the_rustbelt]

"Saving Jobs ... We do this with "Medicare for All". Medicare for All would help re-capitalize business (especially manufacturing), school districts, state and local government, individual payers and the under and uninsured."

So how do we pay for this? Short-term? Long-term?

[Bruce Wilder]

ndk: "As fears of the solvency of the U.S. Treasury/Fed increase, real interest rates will rise too."

If the solvency of the U.S. government is called into doubt, we'll have bigger problems than the state of real interest rates. Besides, if solvency becomes the problem, the currency will begin to hyper-inflate, and real interest rates will become incalculable -- not that anyone would care.

Besides, we are a long, long way from having U.S. government solvency called into question.

Barkley Rosser is right. You should take a pill, and consider the priorities.

The immediate threat of deflation, which comes from two sources. First, the collapse of housing values has driven a major de-leveraging of mortgage-based debt. That debt -- money in an extended form, per Sims -- is imploding, and without it in circulation, substantial downward pressure on prices ensues. Second, the adjustment of consumer spending has brought on a major recession -- a contraction in business activity in response to primarily to lower consumer spending, but also in response to lower business investment in anticipation of the recession.

It is the recession, which threatens a downward spiral. And, a major program of spending by the Federal government to take up resources idled by the recession is necessary to stop the recession-induced deflationary spiral.

Worrying about the effect of the additional borrowing on solvency is kind of silly at this point. The Federal Reserve will accommodate the additional debt, meaning that, in effect, the Federal Reserve will buy it, with cash dollars specially printed for the occasion. (Whoppee! A Party!)

The risk, assuming that the Federal spending is massive enough, becomes entirely inflationary. This is by design. Between inflation and deflation, inflation is the lesser of the twin evils, and much the easier to deal with.

The real interest rate risk, readily apparent in the market, is brought on by deflation. We must stop deflation. The output gap and slack resources imposed by the recession are deflationary, and their deflationary impact has to be neutralized to arrest the deflationary spiral.

At the end of this episode, there will, in theory, be a lot more Treasury debt abroad in the land. How, exactly, it is distributed may become a serious policy issue. It seems doubtful that demand for Treasuries abroad, for use as reserves, will be enhanced by this experience. (Understatement used for effect.) This implies a certain inflationary pressure from abroad.

The Federal Reserve, itself, will probably hold a much larger stock of Treasuries than before. I'm just guessing, but after this episode, the Fed will probably want to display a much larger balance sheet for quite some time.

Household savings rates in the U.S. will be higher. Since they were negative, it would be hard to imagine them going lower. Some of the national debt will be absorbed there.

Along about 2020, the U.S. will probably be feeling suicidal enough to try out one of Mitt Romney's sons as decider-in-chief, because next to a dry drunk, the guy you most want to have a beer with is an abstemious Mormon. But, hey, why worry?

[Bruce Wilder]

s-t-r: "So how do we pay for this? Short-term? Long-term?"

Reduce military expenditures:

We stop fighting a pointless, perpetual war in the Middle East over oil, which oil is mostly going to be purchased by Europe and China anyway, with the money going to ungrateful Arabs.

We stop spending billions on a missile shield that will never, ever work and just annoys Russia.

Etc.

We cut the financial sector in half, reducing the Wall Street tax on everyone and everything.

Reform corporate governance to strengthen the hand of shareholders against a self-serving cadre of corporate executives, reducing the corporate-executive-Hollywood-salary-and-bonus tax on everything and everyone.

We invest aggressively in anything and everything, which will reduce the national expenditure on imported petroleum, eliminating the Saudi/Bush tax on everyone and everything.

We tax rich people. The top 1% enjoy one-fifth of the national income -- take half of it, and you've satisfied half the Federal government's fiscal need. Half and Half.
Increase the top rate of income tax to 70%.
Restore confiscatory inheritance taxes.
Tax capital income as rates similar to labor compensation.

Tax advertising in all its forms and media. Calibrated to the correct rate, an advertising tax will serve to reduce the propaganda tax on everything and everyone.

[ndk]

But look at 10-year credit-default swaps on the U.S. government (56 bips the last time I checked). That's not AAA.

a, 60 bps now.

If you look at a history of real yields, you can very clearly watch them increase every time the U.S. government takes on more risk. They were actually declining before Bear Stearns went down. They then started creeping back up slowly, until Lehman Bros. went under.

Barkley, the failure of those firms leads to a direct result of increased government real debt load. It will stand behind the promises made by these corporations when they fail, so the government's debt is much larger than it seems if you simply look at its face value. Remember there are FDIC guarantees, various other new acronym guarantees, the need to save too-big-to-fail firms, PBGC, and so on. Goldman Sachs is issuing FDIC-backed debt. You can't observe this solvency risk directly through T-bills because of deflation and their short duration, but you can see it in real yields across the curve and in CDS.

Anyway, given the totality of the fears you've expressed, it's clear what policy you should be advocating. The Fed should quantitatively ease by buying longer-maturity Treasuries.

Walt, if I'm right and the problem is people pricing in the insolvency of the government, increasing the government's debt load(Fed/Treasury combined), no matter how, is wrong. It's being increased right now through greater guarantees and deflation worsening.

[Bruce Wilder]

ndk, increases in the risk of gov't insolvency are fundamentally inflationary, not deflationary.

[Bruce Wilder]

ndk: "increasing the government's debt load(Fed/Treasury combined), no matter how, is wrong."

"no matter how" ??!?

It's all about "how".

This business of trying to dam private insolvency problems with gov't and Fed guarantees has definitely run its course, and is counter-productive at the margin. I think you see that more clearly than most.

But, Federal spending on goods and services are a different "how".

The deflationary spiral is driven, in part, by the contraction in business activity and the decline in aggregate demand. Additional Federal spending can arrest that contraction/decline, and thus that source of deflationary pressure.

[Walt]

Quantitative easing doesn't increase the government's debt. It decreases it. The government buys debt, and issues money. Voila, there's less government debt in circulation, and insolvency risk goes down, not up.

[ndk]

Again, many of you seem to believe we can easily create inflation if we just try hard enough and spend enough money. I don't disagree with that: the Fed could always just start buying up anything in sight. But it can't create solvency through this process. It can only transfer insolvency to its own balance sheet. As the Fed + Treasury become more and more insolvent, people will demand a higher real rate of interest incorporating the larger risk premium, which is itself more recessionary and deflationary.

There may well be an inflection point beyond which we create enough inflation, future revenue, and increased seigniorage that the government would regain solvency. I suggest that inflection point is very far off, and it's hard to reach, because there's a strong feedback loop fighting you every step of the way.

And even if I'm wrong and you do get there, there are legitimate questions about what to do then, and whether you're any better off than when you started.

[ndk]

Quantitative easing doesn't increase the government's debt. It decreases it. The government buys debt, and issues money. Voila, there's less government debt in circulation, and insolvency risk goes down, not up.

Koen addresses this thesis here.

[Fred]

Arguing with NDK stuck-on-stupid types is hopeless. Like the other Austrians, he's probably got all his money in long treasuries or CDs or else is on a pension and thus deflation is in his economic interests. Follow the money, as the journalists say.

However, I will try to clarify the mess he has made of things. The government has an infinite capacity to deficit spend and run up debt. It can no more go bankrupt than the universe can run out of zeros to put at the end of someone's bank account statement. The consequence of deficit spending will be either inflation and/or a decline in the currency and/or high real interest rates. High real interest rates are bad because they suppress investment spending, and thus growth, and thus should be avoided. Given that we are heading towards deflation and have been running a massive trade deficit for way too long, inflationary pressures would be good at this time. Once the crisis is over, we raise taxes so as to reduce the budget deficit and/or run a surplus, so as eliminate the inflationary pressures. Currency devaluation is inflationary pressure in another guise, and nothing to be feared. It's that simple.

Under classical Keynesian analysis, deflation acts first against the entrepreneur, who is the source of all prosperity. Anyone who urges deflation is effectively urging that we transfer wealth and income from the producers of prosperty to the parasite classes (the rentiers, the pensioners, the government employees).

[Fred]

Oh, to anticipate NDK's next piece of stupidity, the government effectively controls interest rates, if it wants to.

[ndk]

As long as the Bank does not recognize the unrealized losses on held-to-maturity JGBs, the key question with regard to maintaining its financial soundness in the accounting sense is whether there is a possibility that the Bank will be required to sell a large volume of its JGB holdings in the near future.

Specificially, Ueda is pointing out that in the event of success in sparking inflation through the purchase of long-term bonds, the bank could have to sell these bonds or their own Fed bonds to soak up the extra inflation. If they did so, they may face more insolvency as a result. The larger the purchase of long-dated bonds, the more the risk increases.

If investors realize this, they increase the risk premium they charge, causing real interest rates to rise and deflation to worsen until you hit the inflection point. It increases the probability of Sims' unfortunate binary outcomes.

[Bruce Wilder]

ndk: "As the Fed + Treasury become more and more insolvent, people will demand a higher real rate of interest incorporating the larger risk premium, which is itself more recessionary and deflationary."

So much to unpack.

The Fed and the Treasury are not the same entity. The Fed "buying up everything" and the U.S. government buying goods and services will have different effects. In the present circumstance, it is critically important that the Federal government buy goods and services in sufficient volume as to substantially eliminate excess slack in the economy (and the deflationary pressure it creates).

If both Fed and Treasury became insolvent, people could demand a higher real interest rate until they were blue in the face. It wouldn't mean anything. You're talking about circumstances in which the value of a fiat currency as a denominator of value is becoming worthless. No measuring stick, no measurement, and, effectively, no distance or length. Worrying about the state of real interest rates in a circumstance in which the currency is worthless is silly.

[ndk]

Fred, thanks for trying to improve upon my apparent stupidity.

Like the other Austrians, he's probably got all his money in long treasuries or CDs or else is on a pension and thus deflation is in his economic interests. Follow the money, as the journalists say.

No. I wish I had, because I'd have done a lot better, but I don't see this ending well for the USD and I'm not a trader.

However, I will try to clarify the mess he has made of things. The government has an infinite capacity to deficit spend and run up debt. It can no more go bankrupt than the universe can run out of zeros to put at the end of someone's bank account statement.

You're claiming that national governments can't go bankrupt? I may have a counterexample or two.

The consequence of deficit spending will be either inflation and/or a decline in the currency and/or high real interest rates.

I agree. We're getting higher real interest rates now, which is more deflationary. If suddenly we burst out of this monetary phase through creating a sufficient amount of money, we get very high inflation with limited ability to control it.

Given that we are heading towards deflation and have been running a massive trade deficit for way too long, inflationary pressures would be good at this time. Once the crisis is over, we raise taxes so as to reduce the budget deficit and/or run a surplus, so as eliminate the inflationary pressures.

The inflationary pressures would make a lot of banks go even further under, as their assets often have fixed rates. Increasing taxes in this kind of environment would be politically impalatable, and make recovery harder.

Currency devaluation is inflationary pressure in another guise, and nothing to be feared. It's that simple.

Currency devaluation strikes me as a real issue. We're still a net importer of all kinds of things that we need to run our economy, like oil.

[ndk]

The Fed and the Treasury are not the same entity. The Fed "buying up everything" and the U.S. government buying goods and services will have different effects.

Quoting Buiter:

"However, the fact that the central bank is, from a
financial point of view, an integral part of the state,
does not depend on the formal legal niceties of stock
ownership. Even if the central bank has formal or de-
facto operational independence, it is an integral part of
a sovereign state. Their balance sheets and profit and
loss accounts should be included in the consolidated
financial accounts of the nation state to which they
belong."

Worrying about the state of real interest rates in a circumstance in which the currency is worthless is silly.

I agree. Let's not end up there.

[Bruce Wilder]

The larger the outstanding balance of long-dated bonds in the national debt, the greater is the benefit to the government of inflation.

Inflation is also an incentive to not hold cash. The vast reservoirs of money, which have in recent months poured into short-term Treasuries, would, in the face of creditable expectations of inflation, pour out again seeking longer-term investments with a higher rate of return. Whether, accounting for expected inflation, such investments yielded much of a real return would depend on the outcome of competition.

We want inflation. And, if the Federal government would spend enough, we will have it.

[Bruce Wilder]

ndk: "The inflationary pressures would make a lot of banks go even further under, as their assets often have fixed rates."

Not likely. Banks just need a normally sloped yield curve, to find all right with their world.

[Bruce Wilder]

ndk: "We're getting higher real interest rates now, which is more deflationary."

You keep saying that. Deflation drives up real interest rates. The arrow of causality flows from deflation to real interest rates.

The goal must be to stop deflation. The logical way to do that is to cause inflation. Spend money on goods and services, increasing aggregate demand until it begins to drive up prices.

[ndk]

Not likely. Banks just need a normally sloped yield curve, to find all right with their world.

That's true for profit from lending operations, but I'm concerned about long maturity assets already on their books.

The vast reservoirs of money, which have in recent months poured into short-term Treasuries, would, in the face of creditable expectations of inflation, pour out again seeking longer-term investments with a higher rate of return.

Yes, I agree, if you hit the inflection point. At that point fighting inflation with the assets on the books of the Fed becomes difficult, because it can't sell them. Until you hit that inflection point, the risk of insolvency of the consolidated government books only increases, which only causes real interest rates to rise and deflation to get worse.

I'm starting to realize why Krugman wants to hit that inflection point sooner rather than later, because it gets more and more binary as time wears on. Maybe prudence is folly past that certain, very high threshold. Spending is folly until then. On that, we might agree.

For some reason, though, the market doesn't believe we can or will hit that inflection point, or the 30 year wouldn't be at 3.45%. I'm trying to understand why.