soph·is·try (s f -str
). n. pl. soph·is·tries. 1. Plausible but
fallacious argumentation. 2. A plausible but misleading or fallacious
argument.
I see the Cullen Roche is back at it again, telling us all about the wonders
of modern money. The Biggest Myths in Economics
I will take these myths, and comment on them one by
one. Some things make sense, and others, not so much. But perhaps
the discussion will help to shed some light.
I am going to try to do it simply and in straightforward language, because
that is often the best antidote to sophistry.
1) The government “prints money”.
The government really doesn’t 'print money' in any meaningful sense. Most of
the money in our monetary system exists because banks created it through the
loan creation process. The only money the government really creates is due to
the process of notes and coin creation. These forms of money, however, exist
to facilitate the use of bank accounts.
This is the 'I didn't do it, because the guys who are working for me did it'
argument.
As you might recall, the banks in the US, and most other places, operated
under a license and regulation of the government. The banks are part of the
Federal Reserve System. They create money under the supervision and
regulation of the Federal Reserve Bank, which in turn is answerable to the
government.
Most of the time the money is created, organically if you will, through
economic activity. The Fed exercises quite a bit of direct and indirect
control over this process as both actor in the markets and a regulator. This
is the very basis of the Federal Reserve.
At other times, the Fed is able to create money on its own volition, by
expanding its Balance Sheet. It can create money at will, and uses it to
enact its policy objectives. Whether you say 'print' or 'create' money is a
matter of usage, as they are both essentially the same in this context unless
you are given to splitting hairs.
You want to know the difference here? If some bank or
person started 'printing' its own money apart from the Federal Reserve
system or the rules of the government over commercial paper they would
shut them down in a Manhattan minute. Just ask the
Liberty coins guy. The almighty dollar is a jealous god.
There were times in the past when the 'currency of the US' was created by
private parties and circulated. That is not the case now, except
in the fevered minds of creative imaginations.
2) Banks “lend reserves”
This myth derives from the concept of the money multiplier, which we all
learn in any basic econ course. It implies that banks who have $100 in
reserves will then “multiply” this money 10X or whatever. This was a
big cause of the many hyperinflation predictions back in 2009 after QE
started and reserve balances at banks exploded due to the Fed’s balance sheet
expansion. But banks don’t make lending decisions based on the quantity
of reserves they hold.
Banks lend to creditworthy customers who have demand for loans. If
there’s no demand for loans it really doesn’t matter whether the bank wants
to make loans.
This one gets definitionally
tricky, because it involves the terminology of bank accounting and its own
particular jargon. But let us cut to the heart of it by saying that banks
make loans with some regards to their assets. A person cannot just stand
up with no money in their pockets and say, I am a
bank and am going to start making loans. They need to be licensed by the
government, and must adhere to certain requirements from their
books. Those nasty things like leverage, risk, etc.
As for Banks being in the business of making loans, that is nonsense. Banks
are in the business of making money, and we should never forget that.
Sitting idly on what in another business would be called working
capital does not do them much good. And people tend to mistake 'working
capital' for 'reserves' and that's where we go off into the jargon
wilderness.
What is a creditworthy loan? This is not some black and white
threshold, good or bad, but more like better or worse, an analog measurement
of risk and reward. Anyone who has ever funded competing projects in
corporations understand this. It is intimately tied
to risk return and competing opportunities.
I would certainly think that most people understand that making commercial
loans for some meager basis points in return over the long haul is
boring stuff compared to the opportunities to be had in gaming hot money
markets for outsized gains and large bonuses tied to short term results.
And that is the heart of much of the problems in the financial system today.
Speculation is crowding out investment from the commercial banking system due
to the repeal of Glass-Steagall, and the laxity of
regulating the abusive practices of large and powerful players in the
markets.
3) The US government is running
out of money and must pay back the national debt.
There seems to be this strange belief that a nation with a printing press whose debt is denominated in the currency it can
print, can become insolvent. There are many people who complain about the
government 'printing money' while also worrying about government solvency.
It’s a very strange contradiction...
As I’ve described before, the US government is a contingent currency issuer
and could always create the money needed to fund its own operations. Now,
that doesn’t mean that this won’t contribute to high inflation or currency
debasement, but solvency (not having access to money) is not the same thing
as inflation (issuing too much money).
This is a nice piece of sophistry because while it
knocks down a thesis, it does not prove its antithesis.
Because the US government is NOT running out of money, and it does NOT have
to pay back the national debt, that does not mean
that the national debt has no limit. It just means that we have not yet
reached it, whatever that may be.
At some point you have to get off the theoretical merry-go-round and try to
exchange some of that money which you declare that you have for real goods.
And the perspective of the counterparty weighs in heavily on that transaction
I daresay. One only has to look at the many, many failed currencies
throughout history, from 'contingent currency issuers,' in order to
understand the fallacy of this argument.
Certainly you can force your own citizens to adhere to your
commands, as the MMT crowd are often wont to
imply. But it is still a larger world out there, and absent one world
government, there are some degrees of freedom in determining currency
valuations.
4) The national debt is a burden
that will ruin our children’s futures.
The national debt is often portrayed as something that must be “paid
back”. As if we are all born with a bill attached to our feet that we have to
pay back to the government over the course of our lives. Of course, that’s
not true at all. In fact, the national debt has been expanding since the dawn
of the USA and has grown as the needs of US citizens have expanded over time.
There’s really no such thing as “paying back” the national debt unless you
think the government should be entirely eliminated (which I think most of us
would agree is a pretty unrealistic view of the world).
This one is almost the same as myth number 3. The
national debt is something that will always exist in a debt based system. The
pricing of debt in a marketplace is how the Federal Reserve system and
Treasury are theoretically restrained from the excessive creation
of money.
The very money in your pocket is itself is a 'note' of obligation on the
Balance Sheet of the Fed, and overall a debt obligation of the
Treasury. The 'full faith and credit' of the United States if you will.
But that does not mean that the debt cannot become a burden on our children.
If the debt is misspent and squandered and allowed to outgrow the capacity to
manage it, it can become a very real burden.
But I find that those who make this argument are typically those who have
already grabbed a good portion of the money from some financial bubble, and
now seek to hold their gains. Debt must be managed.
To this point Cullen says "All government spending isn’t necessarily
bad just like all private sector spending isn’t necessarily good."
And I agree with this completely.
5) QE is inflationary 'money printing' and/or 'debt
monetization'
Quantitative Easing (QE) is a form of monetary policy that involves the Fed
expanding its balance sheet in order to alter the composition of the private
sector’s balance sheet. This means the Fed is creating new money and buying
private sector assets like MBS or T-bonds.
When the Fed buys these assets it is technically 'printing' new money, but it
is also effectively 'unprinting' the T-bond or MBS
from the private sector. When people call QE 'money printing'
they imply that there is magically more money in the private sector which
will chase more goods which will lead to higher inflation. But since QE
doesn’t change the private sector’s net worth (because it’s a simple swap)
the operation is actually a lot more like changing a savings account into a
checking account. This isn’t 'money printing' in the sense that some imply.
Well
yeah, it is money printing, although I agree it is not magical. The Fed
simply expands its Balance Sheet and creates, or prints if you will, Federal
Reserve notes of zero duration, also known as dollars, and exchanges them for
assets of various durations and quality at non-market based prices. It is not
limited to Treasury debt, but can include almost anything really according to
the Fed, whether it be toxic debt mortgages, or
common stocks, etc.
And the Fed is not 'unprinting' anything, until it
either writes off the debt, or return it to its
issuer. The Fed is a private corporation. You can say that the
Fed withdraws the liquidity from the market place by keeping it relativelhy inactive because the Fed does not purchase
many things, but even that is no longer the case. The Fed has grown
into quite the organization, with its own police force. It merely surrenders any 'profits' remaining after all its
discretionary expenses back to the Treasury.
If this was such a simple and benign swap why else would they do it? It is one
of the primary levers the Fed uses to influence monetary policy.
They are increasing and changing the character of the money supply in the
course of managing it. It is what they do for God's sake, besides riding herd
on their banks who normally create the money for
them, but occasionally get derailed by some financial bubble of their own
creation.
7) Government spending drives up
interest rates and bond vigilantes control interest rates.
Many economists believe that government spending 'crowds out' private
investment by forcing the private sector to compete for bonds in the mythical
'loanable funds market.' The last 5 years blew huge holes in this concept. As
the US government’s spending and deficits rose
interest rates continue to drop like a rock. Clearly, government spending
doesn’t necessarily drive up interest rates.
And in fact, the Fed could theoretically control the entire yield curve of US
government debt if it merely targeted a rate. All it would have to do is
declare a rate and challenge any bond trader to compete at higher rates with
the Fed’s bottomless barrel of reserves. Obviously, the Fed would win in
setting the price because it is the reserve monopolist. So, the government
could actually spend gazillions of dollars and set its rates at 0%
permanently (which might cause high inflation, but you get the message).
It
is not government spending that drives up interest rates, but that does not
mean government spending cannot drive up interest rates. It sure as hell
can.
And I would hope to think that bond vigilantes can help to control interest
rates, otherwise the entire Federal Reserve system and the US dollar is based
on a fallacy. See what Mr. Bernanke has to say below. This is the confidence
on which the dollar rests.
In fact the Fed COULD exercise reserve monopolist powers
and print all the money it wishes at zero rates. And the 'vigilantes'
could respond by shifting their wealth into other non-dollar instruments, en
masse.
What is somewhat confusing is that the relationship is not
straightforward, but is a somewhat non-linear dynamic with a lag. You can get
away with quite a bit of economic behavior in the short term. But eventually
you can reach a tipping point, if there remain enough agents who are free to
dissent from the dictates of a central authority that has fallen into error,
aka 'vigilantes.'
8) The Fed was created by a secret
cabal of bankers to wreck the US economy.
The Fed is a very confusing and sophisticated entity. The Fed catches a lot
of flak because it doesn’t always execute monetary policy effectively. But
monetary policy is not the reason why the Fed was created. The Fed was
created to help stabilize the US payments system and provide a clearinghouse
where banks could meet to help settle interbank payments.
...So yes, the Fed exists to support banks. And yes, the Fed often makes
mistakes executing policies. But its design and structure is actually quite
logical and its creation is not nearly as conspiratorial or malicious as many
make it out to be.
This is reductio ad absurdam.
The Fed is
not a monster or inherently evil. But that does not make it good.
The Fed was created in somewhat extraordinary circumstances, wrapped in
political secrecy in the aftermath of a banking crisis. And it was
driven by a small group of powerful men who united to promote a common
purpose. I will not speak to their motives.
There is a long controversy about the proper role of a central bank in the
US, going back to its very founding, and this treatment makes light of that.
It is a great power to create and distribute money, that
can be used for good or ill. And therefore it must be constrained, and
subject to oversight. And history shows that this power is frequently abused.
9) Fallacy
of composition.
The biggest mistake in modern macroeconomics is probably the fallacy of
composition. This is taking a concept that applies to an individual and
applying it to everyone.
Could not agree more, especially if you extend it to anecdotal information.
But I would tend to refer to it as the fallacy of reasoning from the
particular to the general. But I would not call it 'the biggest.'
One of the most perennial myths is that a skill in making
money, especially through financial speculation, is the sign of
wisdom in other things. Some of the best traders I have known are
borderline savants and white collar criminals, whom I would hardly trust to
handle my family's future.
Alas, wealth and beauty are not always companions of virtue in this
world. They become accustomed to obsequiousness, and lose site of their common humanity. And there is
nothing sadder or more tedious than a man who has become wealthy, who
decides to grace the public with his wisdom, bad haircut and all.
I think a more pernicious and prevalent economic myth is the notion that
economics can dictate public policy through some appeal to economic laws
as if they were physical laws like gravity. Public policy is best decided by
determining goals and priorities and then allowing many things, including
economics, to shape the implementation of that policy.
But economics has been elevated to a position in our societies which is
wholly inappropriate and a source of great mischief, especially when the truly
dangerous myths like 'naturally efficient markets' become the basis for
policy decisions without proper regard for their effects. The 'austerity
for the sake of the public while sustaining corrupt practices' myth is
perhaps the most cruel and appalling.
10)
Economics is a science.
Economics is often thought of as a science when the reality is that most of
economics is just politics masquerading as operational facts.
Economics
is a social science, and not a physical science. There are plenty of facts,
and somewhat ironically Mr. Cullen has just leaned heavily on quite of few of
the ones he tends to favor, whether they are right or not.
The worst of it is when economics is used by those who claim an 'authority'
from it to promote policies that are quackery, as we have seen all too much
in the past twenty years in particular with regard to the natural power of
'the Market.'
What concerns me though is the follow on to this declaration of the myth of economics as science. It is that
extreme resort of relativism which holds that since economics is
all bullshit, why not use it, and shamelessly, to promote your particular
point of view, wrapping it in as much jargon and intimidating hoo hah as you can manage? Since there is no
science and no consequences, let us just do as we please. And that is a
sophistry of the first order.
And this has long been my objection to much that has been said and is being
said about money by those most modern of thinkers, who believe that
since there is no god of consequences, then everything is lawful.
Speaking about money, I like quite a bit what Mr. Bernanke has written about
money in this essay below. I would like you to read it again. It speaks
volumes.
"What
has this got to do with monetary policy? Like
gold, U.S. dollars have value only to the extent that they are strictly
limited in supply. But the U.S.
government has a technology, called a printing press (or, today, its
electronic equivalent), that allows it to produce as many U.S. dollars as it
wishes at essentially no cost.
By increasing the number of U.S. dollars
in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a
dollar in terms of goods and services, which is equivalent to raising the
prices in dollars of those goods and services. We conclude that, under a
paper-money system, a determined
government can always generate higher spending and hence positive inflation.
Of course, the U.S. government is not going to print money and distribute it
willy-nilly (although as we will see later, there are practical policies that
approximate this behavior). Normally, money
is injected into the economy through asset purchases by the Federal Reserve.
To stimulate aggregate spending when short-term interest rates have reached
zero, the Fed must expand the scale of its asset purchases or, possibly,
expand the menu of assets that it buys.
Alternatively, the Fed could find other ways of injecting money into the
system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each
method of adding money to the economy has advantages and drawbacks, both
technical and economic.
One important concern in practice is that calibrating
the economic effects of nonstandard means of injecting money may be
difficult, given our relative lack of experience with such policies. Thus, as I
have stressed already, prevention of deflation remains preferable to having
to cure it.
If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert
itself, and sufficient injections of money will ultimately always reverse a
deflation."
Ben S. Bernanke, Deflation: Making Sure 'It' Doesn't Happen Here