A voice of reason from the comment section

Commenter Negation of Ideology is as perplexed as I am:

Scott is clearly right on this, as I explained on an earlier thread. But I’m still trying to understand the objections. Is it the tiny margin on bonds that primary dealers make? If instead, the Fed simply logged onto Treasury Direct and bought and sold bonds directly from the Treasury would that solve the issue in your eyes?

Then, of course, the monetary base would expand by the Treasury selling less bonds to the public than otherwise.

Maybe that’s the issue we should talk about.  Does the Richman complaint about OMOs disappear if the Fed buys directly from the Treasury?  This is actually identical to my example where the Fed injects the new money by paying the salaries of government employees that would have been working even without the monetary injection.

Or maybe the issue isn’t commissions; it’s who gets the new money (as Richman claims.)  Here’s another way of stating that issue:

Suppose the government buys a billion dollars in goods from two different government contractors.  One is paid by the Fed with $100 bills with big pictures of Ben Franklin.  The other contractor is paid with $100 bills collected via taxes.  Since they are the older bills they have small pictures of Ben Franklin.  Is the contractor who receives the “big Ben” bills somehow better off because he “gets the new money from the Fed?”  If so why?  Do bills with big pictures of Ben have more purchasing power?

Obviously not.  So if getting money directly from the Fed doesn’t give you more purchasing power dollar for dollar, then the issue must by the commission, which Negation of Ideology alluded to.  So Richman’s claim would be that bond dealers get more purchasing power because they get a sweetheart deal from the Fed.  The Fed could inject money more cheaply by buying bonds directly from the Treasury Fed.  Maybe so, but people who know much more about this than me suggests the commissions are extremely low, merely a few basis points.  Perhaps there’s a scandal there, but how can that possibly be of macroeconomic significance?

Commenters also raised the issue of how banks are favored because they get the new money.  We need to contrast two cases:

1.  Normal times.  When T-bills earn positive interest rates banks want ERs about as much as a hole in their head.  The minute they get ERs they try to get rid of these non-interest earning assets by buying other assets, such as T-bills.  All asset prices adjust in the ultra-short run until the public is willing to hold the extra base money as cash.  Then NGDP starts to rise.  In the long run interest rates and real asset prices return to normal after all wages and prices have adjusted.  In the ultra-short run the hot potato effect works through asset prices adjusting, and then over time it works through higher nominal spending on goods and services.

2. The zero bound.  Now banks do want to hold those ERs.  But guess what, the cash will mostly flood into the banks even if first injected to the public.  The public is not allowed to hold deposits at the Fed (much less earn interest on cash).  The public can only hold base money as cash.  If the Fed dumps a $100 billion in base money into the public (say by buying bonds from the public) they will immediately deposit most of that money in the bank.  Now it’s the public that views truck loads of cash as being about as useful as a hole in its head.  If you think it’s unfair that banks end up with most of the new base money when rates are zero, you need to remember that no one else wants it!  OK, the 0.25% IOR program is unfair, and favors banks.  But surely that’s not what all this Cantillon effect stuff is based on.  The program only began in 2008.

PS.  dtoh has also had some good comments on how bond purchases actually work.

PPS.  All those commenters trying to convince me that QE affects stock prices, bond prices, redistributes income, etc., please stop beating that dead horse.  He isn’t going to get any deader.  I know all that.


Tags:

 
 
 

57 Responses to “A voice of reason from the comment section”

  1. Gravatar of Saturos Saturos
    6. December 2012 at 07:02

    Unrelatedly, I guess, Tyler tweeted this paper on IOR a few hours ago: http://libertystreeteconomics.newyorkfed.org/2012/12/why-or-why-not-keep-paying-interest-on-excess-reserves.html

    Eh, and he also linked to this debate on his blog yesterday.

  2. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 07:06

    The objection is to your perverse reading of Richman.

    The objection is to our perverse characterization of your perverse reading of Richman as as some sort of engagement with Hayek’s macro.

  3. Gravatar of Gabe Gabe
    6. December 2012 at 07:09

    The resources going to corrupt and useless(often destructive) government contractors helps destroy the structure of the economy in either case. What is being rewarded is political smooziness with the politicians. The way to get in a crony-capitalist society is not offering help to your fellow man that he will voluntarily pay for…it is hiring prostitutes for corruopted officials to get them to force others to pay you. The fed helps make this whole proccess easier. It is bad for the economy when only GE, Lockheed Martin and Goldman Sachs can get the low interest loans(they get the money first) while lower class individuals can’t. It is bad for the structure of the economy when the highest paying careers all run through primary dealers that get easy money from commissions/fees/ bid/ask market info on the the bond market. When the best engineers and potential scientist all see that the path towards riches is one of these routes and not actually inventiing and making things then that helps gradually erode the economy. If NGDP grows at 5% a year that just hides the gradual and subtle /degradation/corruption to our national work ethic etc. Eventually the rotten system falls down like a 200 year old parasite ridden oak tree, but it might take 50 years for the rot to overtake the system.

  4. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 07:22

    Sheldon Richman now tells us Scott indeed read things into what Sheldon wrote which Sheldon did not say, ie I was directly on point in identifying Scott as having read Richman without charity and perversely:

    Sheldon Richman quotes Scott Sumner: “Sheldon claimed that mainstream economists overlook that part, which is again wrong.”

    Then writes:

    >>I didn’t mention mainstream economists, but I guess when they go to a football game and see the teams huddling, they think the players are talking about them. I was writing for a popular audience, and the overlookers I had in mind are the pundits, op-ed writers, and television commentators, from whom most people get their economic information.<<

  5. Gravatar of Derrill Watson Derrill Watson
    6. December 2012 at 07:22

    “Now it’s the public that views truck loads of cash as being about as useful as a hole in its head. If you think it’s unfair that banks end up with most of the new base money when rates are zero, you need to remember that no one else wants it!”

    I’m confused. I thought ala Beckworth we had excess money demand, but you’re telling me no one wants to hold money. Or do you mean that pieces of green paper are worthless and electronic money still has value so people would like to hold onto a great deal more of it?

  6. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 07:24

    Once again Scott Sumner is shown to be putting words and conceptions in peoples mouths which they did not say.

    There is a pattern here, Scott.

    My plea is for you to take this information to heart.

    Its a well verified pattern at this point.

    Please think about it.

  7. Gravatar of Bill Woolsey Bill Woolsey
    6. December 2012 at 07:27

    Scott:

    I think the big pictures of Franklin is a good thought experiment. I have done the same before with the new money being blue rather than green.

    Anyway, the injection effects are that the Fed buys bonds rather than sending out dollar bills to everyone. Or, perhaps buys cars.

    Now suppose the government never sells any interest bearing debt, and only spends tax money. But there is one exception. They might print up new currency and spend that one some govenrment good. Or it might cut taxes and fund current spending with the newly issued currency. Or, it might just send out the money to all citizens as a special transfer payment.

    However, in reality, the central bank lends money to commerical banks who make short term loans (3 or 6 months) to businesses.

    The central bank never buys any government bonds. It only lends to banks, who in turn only lend to business.

    Now suppose the central bank only lends to old fashioned Savings and Loans and they only make 30 year mortgages.

    These are the injection effects.

    Does the government give out transfers, does it cut taxes, does it spend on some kind of specific government good that it would not have bought otherwise, is the money lent to commercial banks who make commercial loans, is it lent to savings and loans who make 30 year home mortgages.

    Look, I think there is plenty of confusion among “Austrians” on this matter. (Mostly AAN Amateur Austrians of the Net.)

    Some of the comments about if there are no injection effects counterfeiters can’t benefit from printing money shows that.

    I think there are “Austrians” making arguments that suggest that the govermnet contractor getting the big picture dollars is someone benefiting relative to the government contractor who gets the “old” notes.

    Later, you need to at least consider that when you tell these stories about people putting the excess “cash” in the banks and then the banks get rid of it buy buying T-bills, that maybe you should consider what happens if instead they make commercial loans or buy mortgage backed securities.

    In my opinion, Sheldon Richman, a journalist with a Rothbardian background, is unwittingly repeating Rothbardian propoganda. From Rothbard’s perspective, an argument (or perhaps rhetoric) that creates confusion in the listener but motivates them to hate the state is justified.

    Rothbard and Rothbardians have long been promoting the view that inflation is all about benefiting the elite against the interests of teh common people. I think it is about motivating the common people to support a 100% gold standard monetary system. In Rothbardism, any bank that lends any part of checkable depostis and any lending by the a central bank (matching currency) is wrong. These institutions should be storing gold. (Well, there shouldn’t be a central bank.) They are doing wrong by making any of these loans. And obviously, it benefits them to make loans. Why else do they do it? Haven’t you read comments like this?

    Your framing where currency is just printed by government and spent, along with its other sources of funds–borrowing and taxing, and basically forget backing, just misses everything they are talking about.

    In your story, during the period when the liquidity effect occurs, if firms use those interest rates to make judgements about what particular capital goods are worthwhile, and then, turn out to be bad investments at the interest rates that return to normal, then you have the injection effects. But it is all confused because their is an assumption that those firms making the mistakes are actually using the currency with the big ben pictures to buy the capital goods. And that part is mistaken.

  8. Gravatar of Saturos Saturos
    6. December 2012 at 07:38

    Randall Munroe on home-counterfeiting: http://what-if.xkcd.com/23/

    I presume everyone saw the previous installment on economics, also known as (by Tim Harford) the best economics article of all time: http://what-if.xkcd.com/22/

  9. Gravatar of Steve Steve
    6. December 2012 at 07:41

    I think you’re both right.

    The Fed has been targeting bonds, and the privileged that held those bonds have made a huge win, to the detriment of the rest of the $ based world (mainly pension funds, bond-fund holders, other central banks, fed front-running hedge funds have won). Banks making a spread have not made anywhere near this profit and make a small gain (100s of millions, not billions).

    Its understandable that the man in the street is upset by these gains, as his wages are sticky, but he clear sees the wall of money being printed, prices (maybe) going up and his relative wealth and spending power decreasing. the few bucks he has saved up in cash are also diluted. This is the effect people are outraged about.

    Now, a lot of the cash injected is parked at the Fed or buying fast money assets, and not trickling into the economy the way the fed was hoping (as loans made by commercial banks).

    In the end, Ben has had no choice but to widen the scope and target MBS directly in hope that this stimulation mechanism will have the wealth effect he hoped, by stimulating lending at low rates to the general public, re-igniting house purchases and consumption and giving the lift to the economy he is hoping for.

    I think from a pure macro point of view, Scott is right, even though some micro players and historic holders of treasuries have made some money on the initial drop of rates, once rates are low, for all intents and purposes, its pretty much indifferent whether the cash is coming into bonds or MBS or other money transmission mechanisms since he is only really worried about the inflation effect (NGDP) which is broad and will occur in a similar fashion in any direction (if it occurs at all). This is the biggest unknown that (if I understand it correctly) Scott is trying to address.

  10. Gravatar of Becky Hargrove Becky Hargrove
    6. December 2012 at 07:48

    Saturos,
    I still pick up pennies!

    Bill,
    The Rothbardian “elite against the common people” argument also seems to have an underlying cultural element against monetary skills wealth, and towards restoring primacy of land use in wealth creation.

  11. Gravatar of Major_Freedom Major_Freedom
    6. December 2012 at 08:07

    Suppose the government buys a billion dollars in goods from two different government contractors. One is paid by the Fed with $100 bills with big pictures of Ben Franklin. The other contractor is paid with $100 bills collected via taxes. Since they are the older bills they have small pictures of Ben Franklin. Is the contractor who receives the “big Ben” bills somehow better off because he “gets the new money from the Fed?” If so why? Do bills with big pictures of Ben have more purchasing power?

    In this example, you must separate the group that receives the new money first, with the group that contains a money transfer (tax transfer) from one sub-group to the other sub-group, the latter group of which will only receive the new money after the first group spends the new money on the second group’s output. Here, the group that receives the new money first benefits at the expense of those who receive the new money later on.

    Obviously not. So if getting money directly from the Fed doesn’t give you more purchasing power dollar for dollar, then the issue must by the commission, which Negation of Ideology alluded to.

    Negation of Ideology is not correct. He too ignores the mechanics of inflation and tries to believe it’s a wash.

    So Richman’s claim would be that bond dealers get more purchasing power because they get a sweetheart deal from the Fed. The Fed could inject money more cheaply by buying bonds directly from the Treasury Fed. Maybe so, but people who know much more about this than me suggests the commissions are extremely low, merely a few basis points. Perhaps there’s a scandal there, but how can that possibly be of macroeconomic significance?

    It isn’t just commissions! It’s the flow of additional money from person to person, where those who receive the new money first receive more money than they otherwise would have received if they had to sell to cash constrained actors.

    Only if inflation enters every single individual’s bank account at the same time and at the same rate, would there be something close to “it’s a wash.” Nick Rowe gets this point. In his post he postulated 5 different scenarios, the first one where each dollar in existence earns the same rate of interest, paid by the Fed. He writes:

    “The baseline scenario is that all new money is paid as interest on existing money. So every year people earn 10% interest on their money, which exactly offsets the 10% depreciation through inflation. It’s a wash. It’s really just like a stock-split.”

    He is inadvertently admitting the Cantillon Effect is real, because if this interest on money is “a wash”, on the basis that for each individual, their depreciated purchasing power is exactly offset by increased cash, then it is not a wash if only some people get the new money first before all others, because then some (actually it’s a LOT of) people would have depreciated purchasing power, and no increased cash balance!

    Connecting this back to bond sellers, what happens is that while money (everyone’s money) is depreciated because of the Fed’s inflation, only the bond sellers experience an increase in money to offset the depreciation of money. Thus, the bond sellers relatively benefit as compared to everyone else.

    You think the argument you are criticizing is one where individuals gain in some sort of absolute sense, divorced from the rest of civilization. But that isn’t the argument, and that is certainly not what the Cantillon Effect entails. The argument is that there is a relative gain and loss. Some people benefit relatively more than others, even if you think there is no “absolute” gain to the initial receivers!

    You gain relative to me when you sell your assets to the Fed. This is the case even if you sell your $100 bond for the Fed’s $100. Why? Because while I experience the depreciated money along with you, only you receive offsetting money. So that makes you gain purchasing power relative to me. Purchasing power is a concept that relates to inter-personal exchange. It is not absolute and divorced from exchanges.

    Make sense finally?

  12. Gravatar of ssumner ssumner
    6. December 2012 at 08:19

    Saturos, The Fed doesn’t get it. The issue is not whether lower IOR wil lead to lower market interest rates. We should hope for higher market interest rates.

    Greg, Do you have a link for that quotation of mine about Sheldon–I’d like to know the context.

    Derrill, I’m saying most people are happy with their current cash balances, and if someone gave them (or sold them) an extra $100,000 in currency they’d deposit most of it in the bank. Do you agree?

    Bill, You said;

    “Anyway, the injection effects are that the Fed buys bonds rather than sending out dollar bills to everyone. Or, perhaps buys cars.”

    I agree, but that’s not the issue Richman was talking about. He was talking about the issue of who gets the money, not what is purchased.

  13. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 08:23

    Scott, if you gives taxpayers the option of paying taxes or buying low yield bonds from the Government that mature in 50 years is that monetary policy or fiscal policy?

    Say taxpayers buy $1 trillion in 50 year bonds instead of paying $1 trillion in taxes.

    They then loan their $1 trillion in bonds to local Savings & Loans, who use those bonds to finance home mortgages, and then the home builders and workers and nail makers re-loan most of those bonds back to the S & L’s who lather, rince and repeats.

    Explain to me all of the economics if what happens here.

    (And don’t label this an ‘Austrian’ argument — lets not pretend this is an explication of a a complex scientific research program.)

  14. Gravatar of Major_Freedom Major_Freedom
    6. December 2012 at 08:27

    ssumner:

    Commenters also raised the issue of how banks are favored because they get the new money. We need to contrast two cases:

    1. Normal times. When T-bills earn positive interest rates banks want ERs about as much as a hole in their head. The minute they get ERs they try to get rid of these non-interest earning assets by buying other assets, such as T-bills. All asset prices adjust in the ultra-short run until the public is willing to hold the extra base money as cash. Then NGDP starts to rise. In the long run interest rates and real asset prices return to normal after all wages and prices have adjusted. In the ultra-short run the hot potato effect works through assets prices adjusting, and then over time it works through higher nominal spending on goods and services.

    Congrats, you just agreed the Cantillon Effect is real, even with monetary policy “during normal times.”

    That process of money spending “working its way through assets prices adjusting” is a step by step, sequential phenomena. Inflation does not increase all prices instantly at the exact same amount. It raises some prices before others, as additional money is spent and respent from person to person. That is the Cantillon Effect sir!

    You’re so close to understanding the Austrian theory of business cycles, BTW. It is associated with money “working its way throughout the economy, adjusting asset prices, and then over time through higher spending on consumer goods.”

    2. The zero bound. Now banks do want to hold those ERs. But guess what, the cash will mostly flood into the banks even if first injected to the public.

    Yes, but those in “the public” who received the new money, would still have the ability to withdraw and spend that money. They have a right to take possession of it. In this instance, the depreciated money that everyone now owns, is only offset by increased cash to those few in “the public” who first received the new money!

    The public is not allowed to hold deposits at the Fed (much less earn interest on cash). The public can only hold base money as cash. If the Fed dumps a $100 billion in base money into the public (say by buying bonds from the public) they will immediately deposit most of that money in the bank.

    If that happened, then only the bond sellers would see their cash balances rise to offset the depreciated money. Cantillon Effect persists.

    Now it’s the public that views truck loads of cash as being about as useful as a hole in its head. If you think it’s unfair that banks end up with most of the new base money when rates are zero, you need to remember that no one else wants it!

    Hahaha, if nobody wanted it, then nobody would accept it, including the banks. If the banks don’t want it, then they’ll have to find someone else who does. Cash, even truckloads of it, are almost always wanted by someone. I mean, do you know of anyone who is burning truckloads of cash?

    OK, the 0.25% IOR program is unfair, and favors banks. But surely that’s not what all this Cantillon effect stuff is based on. The program only began in 2008.

    It’s not just the IOR (although that is included, since the depreciation in money it brings about, is offset by money going to only the banks, and nobody else. That gives the banks a relative advantage.

    It’s what you just described above of money working its way through the economy, bidding up some prices before other prices!

    Now add into the mix the banks getting trillions of dollars from the Fed, which depreciates everyone’s money, including the banks’ money, but only the banks experience a rise in money to offset it, and you can sense just how large that relative benefit is. It’s like one person taking “only” $0.10 from every money holder on the planet. It’s absolutely gigantic when put in context of the actual argument Richman is making.

  15. Gravatar of dtoh dtoh
    6. December 2012 at 08:33

    Scott,
    You said,

    Maybe so, but people who know much more about this than me suggests the commissions are extremely low, merely a few basis points

    More like a fraction of a basis point.

  16. Gravatar of Tyler Joyner Tyler Joyner
    6. December 2012 at 08:43

    Bill hit the nail on the head, I think.

    I still wonder, though.

    How is this: “PPS. All those commenters trying to convince me that QE affects stock prices, bond prices, redistributes income, etc., please stop beating that dead horse. He isn’t going to get any deader. I know all that.”

    Different from this: “Since Fed-created money reaches particular privileged interests before it filters through the economy, early recipients—banks, securities dealers, government contractors—have the benefit of increased purchasing power before prices rise. Most wage earners and people on fixed incomes, on the other hand, see higher prices before they receive higher nominal incomes or Social Security benefits. Pensioners without cost-of-living adjustments are out of luck.”

    I think your reading of Richman is too narrow. Even if the Fed doesn’t “give” money to a specific securities dealer, they are still “early recipients” of the benefits. They make profits immediately from moves in the prices of financial products, and as you yourself are so fond of pointing out, prices and wages are sticky. So they can then go out and spend those trading profits before nominal prices catch up. They might go out and buy themselves a new Mercedes, or a steak dinner, at unchanged nominal prices.

    I also think your continued assumption that Fed policy exists in a vacuum and does not affect government spending is, to say the least, very very questionable.

    In your example with the two contractors, it’s not which one gets the actual newly printed bills that matters (straw man). What matters is that, in the absence of the new Big Ben dollars, there would have been only $1 billion to be spent. So either one of the contractors would have gotten nothing, or they both would have gotten half a billion, etc. If you think of the monetary base as an enormous pie chart, with individuals and companies having their own slice, what happens in your example is that the nominal pie gets bigger by $1 billion, but the entire amount goes straight to contractor A, who would have otherwise gotten nothing, so the percentage of the monetary base that they control has increased.

  17. Gravatar of Desolation Jones Desolation Jones
    6. December 2012 at 08:52

    Greg Ransom, Sheldon quoted me, not Sumner.

    If he says that he didn’t mean mainstream economists, fine. I’ll take his word it. But I don’t think it was wrong of me to infer that he meant mainstream economists.

    Sheldon said
    “But the Austrian school of economics has long stressed two overlooked aspects of inflation. First, the new money enters the economy at specific points, rather than being distributed evenly through the textbook “helicopter effect.””

    He says “rather than being distributed through textbook helicopter effects”. In other words, “as apposed to what mainstream economists write in their textbooks.” That’s what I got from ti.

  18. Gravatar of Doug M Doug M
    6. December 2012 at 08:58

    Scott,

    Do you really not understand where your critics are coming from or are you being willfully ignorant?

    When the Fed buy financial assets holders of financial assets benefit.

    Read that one more time.

    Richman’s thesis is that the Fed benefits the 1% at the expense of the 99%. Now, there is plenty to attack in that thesis, but you have been focused on an irrelevancy.

    Richman’s thesis is that the Fed benefits the 1% at the expense of the 99%. Now, there is plenty to attack in that thesis, but you have been focused on an irrelvancy.

  19. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 09:05

    Desolation Jones — an easy mistake. What Sheldon wrote tells us Scott did indeed misread Sheldon.

    Here’s what Scott wrote about Sheldon,

    “The second assertion is odd, as the non-neutrality of money is probably the single most heavily researched question in all of macroeconomics. So I am not quite sure why Richman considers it “overlooked.””

    And here’s what Sheldon tell us he had in mind,

    >>I didn’t mention mainstream economists, but I guess when they go to a football game and see the teams huddling, they think the players are talking about them. I was writing for a popular audience, and the overlookers I had in mind are the pundits, op-ed writers, and television commentators, from whom most people get their economic information.<<

    Note well it is not the research of mainstream macroeconomic econometricians.

  20. Gravatar of jknarr jknarr
    6. December 2012 at 09:09

    Scott,
    Yes, “the money” appears to be the monetary base – reserves and currency – the Fed liability side. My take:

    1) In normal times, interest is the compensation that you get for holding debt instead of cash – the risk premium if you will. If the Fed increases interest rates, then it is trying to shift holders out of risky assets and into risk-free debt. Higher rates produce greater debt holdings in the public (inflation constant) and less asset holding.

    2) The zero bound is a symptom of little/no demand for debt – so the price of debt falls to nil. Hence, banks are dying because their business – borrowing and lending – dies. The recession/crisis growth in excess reserves is not a market phenomenon – it accomplished by fiat by the Fed. Banks might demand base money, but they certainly do not compete to get hold of the funding. If the bank comes knocking on your door to repossess your house, wouldn’t you like some instantly-created reserves on hand to buy t-notes and reassure them that you are not illiquid and will keep current?

    Increased excess reserves is an asset on commercial bank balance sheets – if the Fed circumvented the banking system and injected currency into the household sector (instead of boosting bank balance sheets), then there would be massive holdings of physical currency – because banks would be insolvent without reserves – there would be no place to reliably put this new cash. The whole point to IOR installation was that it keeps reserves sequestered, and changes reserves away from a cash equivalent. Physical cash – not reserves – is the ultimate “deliverable”, and is so the ultimate “scarce good”, upon which all other electronic cash contracts are based.

    Also, perhaps we could think of Cantillion effects as balance-sheet based, rather than sector based. Banks simply intermediate credit, and so (once reserves are in place) the strongest balance sheets can tap credit sooner than weak balance sheets (with the US Treasury the biggest balance sheet out there). This only happens as long as banks are capitalized – so the Fed-based excess reserve recapitalizations mostly favors strong-balance-sheet borrowers, and so they become the vector for lending, consumption, and inflation.

    This might be a prudent outcome – you want to reward and expand successful businesses that have managed well and so have the best balance sheets. But banks do not manage their balance sheets well, and yet have strong nominal balance sheets, because they are handed assets by the Fed.

    With zero interest rates, it suggests that marginal creditworthiness in the economy is all tapped out – people now want income, not debt. Yet in response, the Fed creates bank reserves that simply plug holes in commercial bank balance sheets, and do almost nothing to stimulate growth (a la 1933-1935).

    Currency production, by contrast, is usable by all entities in the economy (as opposed to reserves). Currency expansion (1939-1941) might have been the much more effective and overlooked stimulus tool that boosted NGDP and broke the Great Depression.

    But, the Fed, the Treasury, and commercial banks hate currency, much more that households. Households love currency in comparison. Currency has expensive carrying and printing costs for banks, and bears no fees or interest, and transactions are more difficult to trace and tax.

    Reserves, loans and deposits are simply in the interest of the banking system, and can be monitored, fee-ed, charged interest, and taxed. Hence the likely reluctance on the part of authorities to stimulate NGDP effectively via currency production – it’s not in their interest. (Not to mention how it is increasingly difficult to get hold of currency because of ever-larger-in-real-terms money laundering restrictions.)

    Reserves are clearly “special bank money” that households would want, if an equivalent could be produced. Also, base money currency is not equivalent to deposits. Deposits are an option on getting hold of physical on demand. At zero rates, banking simply does not become economical after-fees for a huge proportion of US households. People ought to want to hold and deal with currency, rather than deal with fees and bad bank balance sheets credit risk for no interest return.

    But the banks survive the consequences of their own actions because the Fed gives us no choice. Banking is clearly morally hazardous because of the lender of last resort – why wouldn’t households want a piece of this action? Wouldn’t it be more effective to recapitalize households rather than banks? Households are the epitome of decentralized decision-making (efficient in the aggregate). Ought not the economy ought to be “run” for the benefit of citizens rather than oligarchic banks? This appears to be the root of the emotionality of a seemingly-technical question.

  21. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 09:09

    My apologies Scott, I mistook this quote from you,

    >>“The second assertion is odd, as the non-neutrality of money is probably the single most heavily researched question in all of macroeconomics. So I am not quite sure why Richman considers it “overlooked.”<>“Sheldon claimed that mainstream economists overlook that part, which is again wrong.”<<

    Sheldon didn't say who said it and I assumed he was responding to you. He was responding to an anonymous commenter going by "Desolation Jones".

    I misread what Sheldon had in mind. It happens.

  22. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 09:11

    My apologies Scott, I mistook this quote from you,

    >>“The second assertion is odd, as the non-neutrality of money is probably the single most heavily researched question in all of macroeconomics. So I am not quite sure why Richman considers it “overlooked.”“Sheldon claimed that mainstream economists overlook that part, which is again wrong.”<<

    Sheldon didn't say who said it and I assumed he was responding to you. He was responding to an anonymous commenter going by "Desolation Jones".

    I misread what Sheldon had in mind. It happens.

  23. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 09:11

    the >> marks are wrecking the formating.

  24. Gravatar of Doug M Doug M
    6. December 2012 at 09:14

    “The zero bound. Now banks do want to hold those ERs. But guess what, the cash will mostly flood into the banks even if first injected to the public. The public is not allowed to hold deposits at the Fed (much less earn interest on cash). The public can only hold base money as cash. If the Fed dumps a $100 billion in base money into the public (say by buying bonds from the public) they will immediately deposit most of that money in the bank.”

    This IS the arguement that monetary policy is ineffective at the zero lower bound. If the money doesn’t flow, then no amount of money creation will increase output. This is the problem! What is the solution?

    A higer compensation to take risk would be a start.

  25. Gravatar of dtoh dtoh
    6. December 2012 at 09:17

    Bill Woolsey,

    Later, you need to at least consider that when you tell these stories about people putting the excess “cash” in the banks and then the banks get rid of it buy buying T-bills, that maybe you should consider what happens if instead they make commercial loans or buy mortgage backed securities.

    Bill, important point. The loan market is not as fungible and liquid as Tbills, but I still don’t think it matters very much. The loan/credit markets are still pretty fungible (changes in mortgage rates will also be reflected in business lending rates) and will adjust so that ultimately, whoever “gets” (uses) the money will be those economic players who have the flattest indifference curves between holding financial assets and between spending on real goods/services. A lot of these are going to be cyclical businesses who effect the exchange by borrowing from banks, but they are not necessarily the only ones. Some will be high net worth individuals selling stocks to buy Ferraris and some will be home buyers taking out mortgages to purchase new homes.

    It really doesn’t matter too much how the money is injected, the economic players who actually use the money will be those who at the margin are most willing to exchange financial assets for real goods.

    I’m not saying there are no injections effects, but I do think they are quite small even when viewed from the point of which financial asset the money initially “goes” into.

  26. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 09:17

    When Sheldon explains what he had in mind in what he wrote:

    “I didn’t mention mainstream economists, but I guess when they go to a football game and see the teams huddling, they think the players are talking about them. I was writing for a popular audience, and the overlookers I had in mind are the pundits, op-ed writers, and television commentators, from whom most people get their economic information.”

    It clearly establishes that Scott Sumner was reading things into Sheldon’s mind which weren’t there and that he wasn’t saying, ie it’s clear that Scott was not reading Sheldon with charity.

    Here is what Scott wrote,

    “The second assertion is odd, as the non-neutrality of money is probably the single most heavily researched question in all of macroeconomics. So I am not quite sure why Richman considers it “overlooked.”“

    What Sheldon writes here directly applies then to Scott,

    “”I didn’t mention mainstream economists, but I guess when they go to a football game and see the teams huddling, they think the players are talking about them. I was writing for a popular audience, and the overlookers I had in mind are the pundits, op-ed writers, and television commentators, from whom most people get their economic information.”

    There is nothing odd about the ‘assertion’ because Sheldon doesn’t have mainstream macroeconomic econometricians in mind when he brings up the neglect or lack of understanding of Austrian account of non-neutral money.

  27. Gravatar of Scott Sumner Scott Sumner
    6. December 2012 at 09:18

    Doug, You said:

    “When the Fed buy financial assets holders of financial assets benefit.

    Read that one more time.”

    So if the Fed does enough OMOs to create Zimbabwe-style hyperinflation, bondholders benefit. Okaaaaay . . .

    I guess I’m a bit dense.

    Desolation, How dare you assume that “non-Austrians overlook” implies “mainstream economists overlook”! Everyone knows that Austrians like Greg are the mainstream today.

    dtoh, Thanks, that supports my point even more strongly.

  28. Gravatar of StatsGuy StatsGuy
    6. December 2012 at 09:21

    You should do a China post. Interesting stuff going on in China right now. :)

  29. Gravatar of Ron Ronson Ron Ronson
    6. December 2012 at 09:38

    Can I confirm my understanding is correct?

    - The whole point of monetary policy is to adjust the amount of money and the value of money to its optimal level

    - Almost any method of changing the money supply has some distributional side effects. These affects may be unintentional and/or undesired. In any case they would be categorized as fiscal policy.

    - Govts use fiscal policy on a huge scale to carry out distributional effects and this dwarfs any fiscal side- effect of monetary policy. The govt if it chose to could use fiscal policy to back-out any unintended side-effects of monetary policy.

    - Once all this is understood then one is left with a clear view that the govt can get the money supply to any level it wants and minimize the distributional effects of doing this.

    - Therefore we should really be discussing either what the optimum level of the money supply is to optimize the economy or we should be discussing how fiscal policy can be used to benefit society. We should not confuse these 2 discussions.

  30. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 09:50

    Scott writes,

    ” All those commenters trying to convince me that QE affects stock prices, bond prices, redistributes income, etc., please stop beating that dead horse. He isn’t going to get any deader. I know all that.”

    They you are agreeing with Sheldon Richman, on a *non-perverse* reading of what he says.

    So lets start with the reading of Sheldon Richman that begins from the principle of charity.

    A charitable reading of Sheldon Richman begins with this insight:

    “QE affects stock prices, bond prices, redistributes income.”

    Now what is it that is your objection to Sheldon Richman’s article, read in context and with charity and without assuming Sheldon has in mind things he’s directly told us he does not have in mind.

  31. Gravatar of Major_Freedom Major_Freedom
    6. December 2012 at 10:26

    ssumner:

    So if the Fed does enough OMOs to create Zimbabwe-style hyperinflation, bondholders benefit. Okaaaaay . . .

    As I wrote in the other thread which you probably didn’t read, in these instances, if the Fed does enough OMO to make bond prices fall over time, then it must be understood that the fall is LESS than it otherwise would have been had the Fed printed and spent that money on consumer goods instead.

    The price inflation premium that typical bond pricing models include, must be accompanied by the price premium that comes with buying the bonds, rather than buying consumer goods (which would have a premium there if OMO of consumer goods was carried out).

    If the Fed bought bonds, then there will be a RELATIVE gain that goes to the bond holders that those who sell consumer goods would NOT receive, because while consumer goods sellers would own depreciated money and no additional money, the bond holders would own depreciated money AND additional money (from the OMO). So the bond holders gain relative to the consumer goods sellers (and everyone else who doesn’t receive the initial inflation).

    I don’t think it’s a matter of you being dense, it’s a matter of you not understanding the argument you’re addressing.

  32. Gravatar of Major_Freedom Major_Freedom
    6. December 2012 at 10:37

    Remember, if bond prices DO fall because of any OMO bond buying program, then the Fed would be giving money to the bond holders, not anyone else. It doesn’t matter that the bond prices fall. They would have fallen (in real terms) if the Fed did the OMO for consumer goods instead. But if the Fed really did do that, then the bond sellers would just be left with depreciated money, and no additional money. They would be relatively worse off.

    If you are going to postulate massive money printing, then you can’t compare massive money printing to buy bonds, with no massive printing at all. You have to compare massive money printing to buy bonds versus massive money printing to buy consumer goods or whatever.

    Obviously the bond holders are better off if the money goes to them rather than the consumer goods sellers!

    After all, this whole debate is over “who gets the money first”, not whether money is sent to bond holders as compared to nobody.

  33. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 10:43

    About his original article Sheldon Richman tells us,

    “I didn’t mention mainstream economists, but I guess when they go to a football game and see the teams huddling, they think the players are talking about them. I was writing for a popular audience, and the overlookers I had in mind are the pundits, op-ed writers, and television commentators, from whom most people get their economic information.”

    Scott Sumner tells us that he knows that,

    “QE affects stock prices, bond prices, redistributes income, etc.”

    Then read Sheldon Richman’s whole original article in full context,

    http://www.theamericanconservative.com/articles/how-the-rich-rule/

    Then consider all of the uncharitable ways in which Scott Sumner has read Sheldon Richman’s original article with Scott’s original comment (and then leaves the suggestion hanging that Scott’s invented misreading might be “what ‘Austrian’ believe”):

    “This is from an article by Sheldon Richman in the American Conservative:

    But the Austrian school of economic s has long stressed two overlooked aspects of inflation. First, the new money enters the economy at specific points, rather than being distributed evenly through the textbook “helicopter effect.” Second, money is non-neutral.

    Since Fed-created money reaches particular privileged interests before it filters through the economy, early recipients—banks, securities dealers, government contractors—have the benefit of increased purchasing power before prices rise.

    The second assertion is odd, as the non-neutrality of money is probably the single most heavily researched question in all of macroeconomics. So I am not quite sure why Richman considers it “overlooked.”

    The other point is mostly inaccurate. Consider the following four monetary policy injections, where fiscal policy is held constant in each case.

    1. Newly injected base money is used to buy T-bonds from banks.

    2. Newly injected base money is used to buy T-bonds from non-bank securities dealers.

    3. Newly injected base money is used to buy T-bonds from individuals at a special auction excluding bond dealers.

    4. Newly inject base money is used to pay the salaries of government workers, and as a result less money is borrowed by the Treasury. The Treasury then creates and donates a T-bond to the Fed.

    In all four cases the increase in the amount of base money is identical. In all four cases within about one week the increase in currency held by the public and bank reserves is virtually identical. In all four cases the impact on debt held by the public is identical. Thus the impact on interest rates is virtually identical in each case. In all four cases the impact on the purchasing power of various groups in society is virtually identical. Bonds are purchased at market prices. It simply doesn’t matter how the money is injected, if we assume a pure monetary policy with no change in fiscal policy.”

  34. Gravatar of f f
    6. December 2012 at 11:38

    So buying bonds directly from the Treasury eliminates the transaction costs of buying T-bonds from banks, so the Fed should buy directly from the Treasury. But then there’re the transaction costs of creating the bonds in the first place, so the Fed should really just pay gov’t workers so the bonds don’t have to be created. But then there’re the transaction costs of issuing paychecks, so the Fed should just pay the mortgages/rent of those workers and not issue paychecks. But then there’re the transaction costs of sending out mortgage/rent statements, so the Fed should just pay off some of the gov’t employees’ mortgages/rent directly to the mortgage holders/landlords. But then….

  35. Gravatar of Doug M Doug M
    6. December 2012 at 11:51

    “So if the Fed does enough OMOs to create Zimbabwe-style hyperinflation, bondholders benefit. Okaaaaay . . .”

    A little hyperbolic…

    Let’s play the game anyway…

    If the Fed did create hyper-inlation, who would be the winners, and who would be the loosers? The winners would be those who held real assets. The losers would be those who need to buy real assets. Taken to this extreme, the 1% relative to the 99%.

    In peroids of high volatility, the person who has options benefits, and the rich have the options. The Austrian beleive that more often than not the Fed creates volatility.

    Mainstream economics suggests that the Fed creates stability.

    So, if you are going to argue the Austrians, talking about the extremes of Zimbabwe hyperinflation, or $100T open market operations is undermining your case.

  36. Gravatar of Shining Raven Shining Raven
    6. December 2012 at 12:07

    Doug M: “In peroids of high volatility, the person who has options benefits, and the rich have the options.”

    Yes! This! I believe it is a question of liquidity, and the rich have that liquidity, so there is no problem for them. The banks get extra liquidity from the OMOs, and everybody with enough cash or reserves on hand can get into the rising asset market early and benefits, or at least does not loose. Everybody else, not so much.

    And I still don’t see how the arguments that Scott advances here fit together with the usual reasoning.

    Now Scott says:

    “It makes no difference who gets the extra money from the Fed, because the recipient is no wealthier than before (money is swapped for bonds) and hence they have no incentive to spend any more.”

    On the other hand he says about the banks:

    “The minute they get ERs they try to get rid of these non-interest earning assets by buying other assets, such as T-bills. (…) In the ultra-short run the hot potato effect works through asset prices adjusting, and then over time it works through higher nominal spending on goods and services.”

    So what is it? These two statements are obviously not compatible, or what am I missing?

    And I completely agree with Doug M: The scenario at the zero bound of course exactly describes why monetary policy is ineffective in this case – the public does not spend the cash on goods and services, but it is simply re-deposited in banks. Something that Scott describes correctly here, but denies as a problem elsewhere.

    Can somebody please resolve for me why this is not contradictory? Thanks!

  37. Gravatar of Major_Freedom Major_Freedom
    6. December 2012 at 12:08

    Doug M:

    If the Fed did create hyper-inlation, who would be the winners, and who would be the loosers? The winners would be those who held real assets. The losers would be those who need to buy real assets. Taken to this extreme, the 1% relative to the 99%.

    Which is another way of saying those who are the initial receivers of the new money, and those who don’t receive the new money first, but receive existing money from those who (also) don’t receive the new money first, which means the initial receivers benefit relative to everyone else, and within the everyone else group, some benefit relative to others.

    Talking about massive inflation does not undermine Sumner’s case. It is a thought experiment. Take it easy.

  38. Gravatar of Andrew Andrew
    6. December 2012 at 13:49

    Probably anyone here could clear up my confusion about the “dead horse”:

    “All those commenters trying to convince me that QE affects stock prices, bond prices, redistributes income, etc., please stop beating that dead horse. He isn’t going to get any deader. I know all that.”

    So is Scott saying that QE does in fact affect the relative prices of stocks and bonds (and that he is already well aware of this fact)? Or that QE does not have this effect?

    Thanks!

  39. Gravatar of Mike F. Mike F.
    6. December 2012 at 14:31

    When I first heard this Cantillon argument I actually though it made sense (I didn’t think about it very hard) but it’s pretty obvious that Scott Sumner is right about this. I wish Austrians would do some self-assesment and realize that the reason they haven’t done anything important in half a century is that they can’t seem to bring themselves to let go of their dogma even when it is essentially proven to be nonsense. If this were a worthwhile economic movement, there would be some adults in the school somewhere who would stand up and say “alright, alright, look, we thought this at one point but it turns out to not be correct, or circumstances changed or whatever, now we need to move on.” No science has ever moved forward without admitting it was wrong in the past. I’m saying this sincerely as someone who wishes there were a decentralized, free-market, school of macroeconomic thought that someone could take seriously.

  40. Gravatar of bmcburney bmcburney
    6. December 2012 at 15:07

    I’m sorry but I don’t understand, if the Fed’s goal is to get money into the economy by buying Treasury bonds then, necessarily, there must be a distortion of demand for that asset by the fact that a very significant buyer has entered the market for reasons having nothing to do with the investment prospects of the asset. So, in fact, the Fed does not buy $100 million in bonds for $100 million in new money but only, let’s say, $99.95 million in bonds which have been marked up to $100 million for the occasion. As soon as the Fed acts, sellers of the asset they are buying obtain better prices then otherwise. Unless the Fed buys all things simultaneously (which seems to present practical difficulties) the owners of the things which they do buy must obtain a windfall. Of course, it may be a small windfall in a liquid market compared to the volume of the buying but the Fed cannot obtain the desired effect of, for example, lower interest rates unless it distorts the market. And, in fact, even as to the market for US Treasury Bonds, Fed buying does move the market and owners of the asset before the buying begins obtain a windfall.

    When the Fed doubles the amount of a good purchased from a contractor, contractors and other owners of that particular good benefit regardless of whether they are paid in new bills or old. The issue is that the government is buying some amount of extra goods for the purpose of attempting to obtain a macro benefit. When the Fed pays salaries of government workers, those workers (along with others in that field) benefit for the same reason. And, of course, if the government buys exactly the same amount of goods and services as it otherwise would have done this reduces the supply of bonds which would otherwise reach the market and drives up the price of bonds for prior holders of that asset by reducing supply rather than increasing demand for the asset. Somebody always benefits by getting the money first.

  41. Gravatar of Carl Carl
    6. December 2012 at 16:58

    If the Fed stopped buying treasuries, wouldn’t the government need to shrink because it could not sell as much of its debt? And, if that’s the case, why isn’t it reasonable to assume that government employees and contractors benefit disproportionately from Fed OMO?

  42. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 19:12

    Steve Horwitz puts on a little mini-seminar for Scott Sumner:

    http://www.coordinationproblem.org/2012/12/sumner-murphy-richman-and-cantillon-effects.html

  43. Gravatar of Greg Ransom Greg Ransom
    6. December 2012 at 19:34

    many of the points I have been making and Scott Sumner has been ignoring or failing to understand are well expressed by Steve Horwitz here:

    http://www.coordinationproblem.org/2012/12/sumner-murphy-richman-and-cantillon-effects.html

    Note well. Steve gives a plausible reading of what Richman was gesturing toward with his brief brief references and expressive language for a popular audience.

    Sumner gives what he identifies himself as an implausible position — and invoking the principle of anti-charity happily ascribes that implausibility to Richman.

    So far Scott has stuck with the insistence Richman must have in mind Sumner’s invented implausible position.

    Richman has already told us that Sumner has falsely ascribed a view of what Richman had in mind which is erroneous.

    My guess is that Scott will stick with his implausible and uncharitable reading of Richman, rather than engage in a grown-up conversation with Horwitz, or spend a minute gaining the competence in Horwitz’s scientific program needed to converse with Horwitz on a bases of anything but wild and off target speculation of what Horwitz himself has in mind.

    There is a pattern here and I don’t see the pattern breaking.

  44. Gravatar of Mike F. Mike F.
    6. December 2012 at 23:07

    bmcburney – Take your agrument regarding the first thing that the FED buys and apply it uniformly and you will arrive at the same conclusion as Sumner.

    The FED buys bonds and the added demand drives their price up some (probably small) amount before the purchases are complete which creates a (probably small) increase in nominal wealth for the holders of bonds. (It’s worth noting that this would apply to all holders of bonds not just the ones that got the new money.) Then because they feel richer, they don’t put all of the money in the bank, they decide to go buy gold and oil and MBSs. But this increases the demand for gold and oil and MBSs, so if those prices rise then the increase in nominal wealth is passed on to the holders of those assets and the holders of the bonds realize no increase in real wealth. Then if the people who held gold and oil and MBSs buy new toasters, the demand, and therefore the price of toasters will increase, and again, they will have realized no real gain but only passed on the (probably small) increase in nominal wealth. Carry on with this logic and you just end up with higher prices for everything and nobody any better or worse off than anybody else.

  45. Gravatar of Mike F. Mike F.
    6. December 2012 at 23:43

    Carl – I think saying that the existence of FED OMO allows some people to have government jobs who otherwise wouldn’t (which is to say they would most likely have different jobs) is straying a long way from Cantillon effects which is basically what Sumner was trying to say in the second post. It’s fairly obvious that the government can transfer wealth to certain people by throwing money around. If they print a trillion dollars and use it to buy bell peppers, then yeah, the price of bell peppers will go up and pepper farmers will benefit.

    “4. If the central bank bought goods and services at the zero bound, then the direct impact on those markets might be significant. But that would be combining monetary and fiscal policy. More importantly, central banks don’t do that.”

    The point is that it makes no difference which farmer they buy from and it makes no difference if the FED does it through OMO or whether they give the money to the government and they do it. I actually think the second point is a main source of the confusion here. Sumner and his opponents on this seem to have different definitions of “monetary” and “fiscal” policy. Or at least comparing two different sets of alternatives (Sumner: put the money out through OMO or government spending, opponents: put money out vs. don’t put money out) Either way though, it doesn’t matter who gets the money first…

  46. Gravatar of TheMoneyIllusion » If I buy T-bonds, their price rises. If the Fed buys T-bonds, their price (usually) falls TheMoneyIllusion » If I buy T-bonds, their price rises. If the Fed buys T-bonds, their price (usually) falls
    7. December 2012 at 07:10

    [...] my previous post was too pessimistic about influence.  Here’s commenter MikeF: When I first heard this Cantillon argument I actually though it made sense (I didn’t think about [...]

  47. Gravatar of bmcburney bmcburney
    7. December 2012 at 10:34

    Mike F. – Yes, but by getting the new money first the fortunate bondholders get more gold or MBS for their (new) money because the price of the bonds they sold changed first and the price of other things which they may buy changes only when they buy them. Until the new money is fully distributed and all prices are increased the person who receives the first of the new money is in a privileged position as compared to the holders of any other asset for sale.

  48. Gravatar of Mike F. Mike F.
    7. December 2012 at 11:14

    Only if you assume that the price of the bonds rises before they sell them (putting aside th issue of whether or not it actually rises and by how much) but the price of everything else rises after they buy it. If you just assume the same timing

    Increased demand–>price rise–>transactions take place

    in each market, then they get no benefit. You say the price of other things changes only when they buy them but the price of bonds changes only when the FED buys them. So how is it that they can benefit at both ends?

    Even if you assume that their small increase in nominal wealth causes them to buy more toasters and the price of toasters is sticky in the shot run, which is not a crazy thing to imagine, this benefit would probably be miniscule and more importantly, it would not depend on who got the money. The effect would be the same on all bond holders, which was Sumner’s point. He’s not saying OMO has no effect, just no Cantillon effect.

    “All those commenters trying to convince me that QE affects stock prices, bond prices, redistributes income, etc., please stop beating that dead horse. He isn’t going to get any deader. I know all that.”

  49. Gravatar of bmcburney bmcburney
    7. December 2012 at 15:04

    Mike F. – I don’t think I need to assume a rise in price before the sale is consumated. That would make no sense. The price rises as the amount of the asset available at a particular price is exhausted. If the buyer wants more, a higher price is paid until the buyer is satisfied by the amount purchased or the price becomes unacceptable to the buyer. The price rises as the transaction is consumated and as a result of the completed transaction.

    Of course, as I indicated above, if the market is liquid enough compared to the amount of the purchase the rise in price may be small. If not, the effect on prices may be large. But the person on the opposite side of the transaction benefits even if the price does not move greatly because a desired transaction (from the seller’s point of view) has taken place at a price which, by definition, was acceptable to the seller. The seller can then purchase more ounces of gold (or more toasters) then he otherwise would have because he received a better price for his treasuries than he otherwise would have. Yes, his purchases also drive up the prices of gold and toasters but only if and to the extent that the market for gold or toasters is illiquid compared to the size of his purchase.

    Last year the Fed purchased 61% of all US government debt. Did anyone purchase 61% of gold or toasters?

  50. Gravatar of Mike F. Mike F.
    7. December 2012 at 19:24

    All I’m saying is that your conclusion is based solely on your insistence on treating the price adjustments in these markets asymetrically and I don’t think you have given a compelling reason to do so. If the FED announces it will buy bonds, and this increases the price of bonds (which it now seems that it wouldn’t but whatever) because people anticipate the increase in demand. Then if the sellers of gold anticipate the increase in demand from all of those previous holders of bonds who just got richer then this will raise the price of gold. It doesn’t matter when they buy the gold if the increase in demand is predictable.

  51. Gravatar of Negation of Ideology Negation of Ideology
    8. December 2012 at 06:20

    Thanks for calling me a voice of reason!

    As an aside, I’ve often heard the argument that the Fed buying bonds directly from the Treasury would somehow threaten Fed independence. I’ve also heard people claim it would encourage Congress to spend more than buying T-bonds on the secondary market.

    I think both arguments are false. But I wanted to sidestep them for now so I proposed the Fed logging onto Treasury Direct rather than just sending the Treasury a check or crediting the Treasury’s account at the Fed.

    That aside, I think it’s pretty clear we have resolved that it doesn’t matter who gets new money first (unless they get a special deal or unreasonable commission), but it does matter what the Fed buys. Which is exactly what Scott said in the first place.

  52. Gravatar of dtoh dtoh
    8. December 2012 at 06:45

    Negation -

    Abe of the LDP in Japan is proposing exactly the same thing…that the BOJ buy bonds direct from the government.

    Also, I don’t think it actually matters much what the Fed buys as long as it’s liquid. Rates for different securities move in tandem and the size of the Fed purchases are not really large enough to have much impact on spreads.

  53. Gravatar of bmcburney bmcburney
    8. December 2012 at 15:11

    Mike F. – But sellers of gold cannot rationally anticipate that Fed bond buying will immediately increase the price of gold (beyond the overall increase in prices caused by the intervention) becaue they cannot know whether the bond sellers will buy gold or toasters or real estate with their windfall. In fact, if they do increase their price demands in the expectation that some bond sellers will buy gold the bond sellers will switch to other investment options. Presumably, the bond sellers will rationally pursue the best investment strategy available to them. Only the Fed is buying an asset for reasons which are irrational as an investment (the reasons may be rational as macro policy).

    As an historical fact, the Fed bought roughly $1 trillion in US government debt in 2011 and, during roughly the same period, the interest rate on the 10 year went from 3.3% to 1.9%. Was that really a coincidence? People fortunate enough to own 10 year treasuries in January 2011, made one hell of a lot of money on those bonds by January 2012. Neither gold, nor toasters, nor any other asset class came remotely close to that performance. But, staring that evidence in the face, the conclusion is that Cantillion effects don’t exist at all? Really?

  54. Gravatar of ssumner ssumner
    9. December 2012 at 06:06

    bmcburney, You are reversing causation. They bought lots of debt because interest rates plunged as the recovery seemed to sputter out.

  55. Gravatar of bmcburney bmcburney
    9. December 2012 at 12:11

    ssumner – Ok, how do we know that?

  56. Gravatar of ssumner ssumner
    9. December 2012 at 17:30

    bmcburney, They said that they were doing it because of the weak growth in NGDP. There’s overwhelming statistical evidence that slower NGDP growth expectations leads to lower nominal rates on long term bonds.

  57. Gravatar of bmcburney bmcburney
    10. December 2012 at 13:18

    ssumner – Sorry, I did not mean “how do we know why the Fed were buying bonds?” I agree the Fed bought bonds because of weak macro performance. I meant how do we know whether the drop in interest rates was the cause of Fed bond buying (as you contend) rather than a result of expected Fed bond buying?

    If Cantillion effects did exist, or if investors believed they exist, the reaction to news/expectations concerning weak ngdp would be increased expectation that the Fed is about to buy bonds (or otherwise attempt to reduce interest rates). In fact, investors who acted on that assumption by buying the ten year made about 75% on their money in 2011 attempting to “front run” the Fed.

    Correlation between weak ngdp expectation and low interest rates obviously exists but fact alone tells us nothing about causation.

Leave a Reply