Economists = Idiots? Part 1829
It was their idea, so it’s no surprise they like paying interest on reserves, even excess reserves:
For quite a while, the Fed was quite happy to have that money on its books. Indeed, the power to pay interest on reserves was considered a key tool to keep control over all the liquidity the Fed pumped into the system during the financial crisis. The Fed wanted to see bank lending increase, but in a controlled fashion, so as not to fan the flames of an inflation surge.
But as worries about the outlook have risen, the game has changed. Some see a move to drive all those reserves into the economy as a key way to produce better economic growth. Markets got to thinking Fed Chairman Ben Bernanke would indicate this as a possible path when he testifies before the Senate Wednesday and the House of Representatives Thursday on the economic and monetary policy outlook.
Economists, however, think ending the interest on reserves policy would be a bad idea.
Right, because the $2,534,722.22 a year paid in interest on $1 Billion in excess reserves is a drop in the bucket for the U.S. Federal deficit.
And because the risk-free rate of return that features in so many economic models should be different for intermediaries (financial institutions) than wealth-creators (businesses).
And because “excess reserves” are money issued by the government which is inflationary because of the multiplier effect of money—which, of course, assumes the money is being invested. (As this money is, in taxing our tax dollars and giving them to Vikram Pandit, Ken Lewis, Lloyd Blankfein, and Jamie Dimon [in descending order of theft; YMMV].)
And, of course, because that $1 Billion that is not being used in the economy would only produce about $5-8 Billion in GDP, which is roughly, what, 50,000 to 80,000 new jobs?
But, of course, banks have better use for the money than potential workers.
[Barclays Capital’s Joseph Abate] noted much of the money that constitutes this giant pile of reserves is “precautionary liquidity.” If banks didn’t get interest from the Fed they would shift those funds into short-term, low-risk markets such as the repo, Treasury bill and agency discount note markets, where the funds are readily accessible in case of need. Put another way, Abate doesn’t see this money getting tied up in bank loans or the other activities that would help increase credit, in turn boosting overall economic momentum. [emphasis mine]
Oh, well, since they’re not going to lend the money anyway, we should have no trouble paying them interest on it. What is The Fed other than a mattress stuffed by tax dollars?
The key phrase is “precautionary liquidity.” If you assume that the recovery started in June or July of last year,* then you would expect “excess reserves” held for “precautionary liquidity” to have declined over time, as the need for “precautions” is reduced as the economy becomes safer. But that hasn’t been the case.
Choose one (or both) from: (1) the banks don’t believe the economy is recovering or (2) the banks are holding assets on their books at higher levels than they know they are worth, and are therefore using “excess reserves” to cover real losses until they can’t any more.
It is unclear whether Abate sees the banks’s unwillingness to be intermediaries as a feature. But at least he knows not everyone is doing it.
Abate buttressed his argument that banks really just want to stay liquid by noting who is holding reserves at the Fed. He said the 25 largest U.S. banks account for just over half of aggregate reserve levels, with three by themselves making up 21% of the reserves.
So the biggest of the Too Big to Fail banks have decided not to act as financial intermediaries, preferring instead to continue feeding from the taxpayer trough (where the $25MM in interest really is a drop in the bucket) and/or pretend that they are more solvent than they really are.
And, according to the Wall Street Journal, economists believe we should continue to pay those banks for misvaluing their assets and refusing to perform their economic function.
The economic theory I learned is that capital is paid its marginal product. The marginal product of those excess reserves is zero, while the required reserves are intended to explicitly provide “precautionary liquidity.”
Unless the TBTF banks are arguing that the Fed’s current Reserve Requirements are too low—a possibility, perhaps, though the FT cites evidence contrariwise—the basis of all economic and financial theory indicates that they should receive no interest on those reserves.
An “economist” who says otherwise is either lying or selling something.
*I would argue—see yesterday’s post—that June 2009 is rather eliminated by the non-recovery of more than half the states’s job markets a full year later.
Ken,
So $20 Billion should create 1-1.6 MILLION jobs and $100 B to $160 B in GDP growth?
If this were true shouldn’t we see by now 0% unemployment (heck we should be aggressively importing workers) and GDP growth that would make LBJ look like a piker?
How much of the Democratically controlled stimulous package has been spent? $200 B? $400 B?
I should have my pony by now, for sure! Can you send it too me from whatever world your on?
Islam will change
The economists advocating continued interest payments on reserves aren’t idiots, they’re paid propagandists. Your closing sentence would have made a better title than the one you have.
While I agree that the interest payments on reserves should end, I don’t think it will result in any increase in credit extension, both because the banks are insolvent (or close to it), we have the CRE problem that is still unfolding, and people are already buried in debt.
The reason you have shills out there saying that interest payments should continue is for posterity’s sake: the next Milton Friedman will point to those interest payments as the real reason for what’s about to happen (it’s the Fed’s fault!). The last Milton Friedman had to employ sleight of hand to pin the blame on the Fed for the last Great Depression (he focused on M1, which is influenced more by banks and borrowers than Fed policy, instead of M0), so I think the next Milton Friedman will be happy that he won’t have to work so hard to lie. The entire reason the Fed exists is to effect Wall Street policy while providing political cover that appeals to the masses. Before the Fed, the masses blamed the banks.
The key phrase is “precautionary liquidity.” If you assume that the recovery started in June or July of last year,* then you would expect “excess reserves” held for “precautionary liquidity” to have declined over time, as the need for “precautions” is reduced as the economy becomes safer. But that hasn’t been the case.
A point was made a few weeks ago about political uncertainty as a potential cause of lackluster recovery. This “precautionary liquidity” is also a symptom of this political uncertainty, as financial institutions still don’t know what the new capital regime is going to look like and as a result don’t know what capital ratios to target. By historical standards, if you believe their current financial position, which Tao clearly doesn’t, they’re massively overcapitalized.
That’s correct: I don’t believe the banks’ balance sheets.
I also don’t believe for one second that “political uncertainty” has any hand in the lack of a real recovery. The American consumer is tapped out, all the multinationals who can offshore jobs (a euphimism for U.S. decapitalization) have done so, and to the extent that there’s any recover throughout the world, the multinationals are investing there. This is why we’re not seeing a real recovery in the U.S. The only thing people want to invest in here is our national debt, and to the extent that we’re selling that, we’re parking the proceeds on the banks balance sheets as excess reserves on which we pay interest in order to recapitalize the banks.
All the talk about the corporate savings glut studiously ingores the fact that vat majority of the mountain of cash they’re sitting on existed before the financial crisis. Also missing is the fact that this cash is derived from foreign operations, which cannot be repatriated into the U.S. without paying heavy taxes, which is one more reason why that money is not being invested in the U.S. U.S. trade policy, tax policy and accounting rules are set up to funnel capital out of the U.S. and into other markets.
Case in point is AAPL, who announced record earnings yesterday. Their effective tax rate for the quarter was around 24% compared to an effective tax rate of 32% last year, which tells us that most of their earnings growth is due to foreign sales which are not subject to U.S. corporate so long as they are kept offshore. None of that money will find its way back to the U.S. If you look at AAPL’s net sales breakdown in it’s April 10Q, you will see that only $1B of the $4.5B in yoy quarterly sales growth was due to U.S. growth. My guess is that less than $500M of the $3B in profits reported for that quarter are in the U.S. and available for domestic investment.
Our tendency to think that U.S. corporations are sitting on a pile of cash, all of which can be invested in the U.S., is reinforced by the BEA including wordlwide profits (i.e., profits that are not subject to U.S. taxation) in its calculation of U.S. corporate profits. The BEA explains this by saying that since individuals have to pay taxes on all income worldwide, it’s okay to pretend that corporations do, too. My bet is that if we were to tear apart the BEA’s corporate profit numbers and look only at domestic profits, we would see a steady decline over the last thirty years.
“that vat” should be “that the vast”
Repatriation is what we need
I don’t really disagree with your analysis. It’s accurate. Other than the precision of your comment on uncertainty.
Uncertainty does have an impact on small and mid sized businesses for whom any uncertainty is amplified by the lens of economic stress and credit deprivation. Small business is tapped out as well as the consumer. Medium business is not in any better condition.
We have visibility into advertising, marketing and product investment decisions at fortune 250 businesses and their uncertainty is not an issue of taxation, or of regulation, but of a general anti-business sentiment, disbelief in any assumption of the consumer returning to past spending patterns, and a general economic uncertainty due to the inability of the state to encourage consumption. To that degree, there is some ‘waiting’ going on because the state has become seemingly incompetent.
But for a visible change to occur in the US, we need to animate small business credit, labor, and the trades, and to animate all three, we have to redirect production to ends other than housing and commercial real estate. A move of that scale will take both the state and large business working together. And for a variety of reasons this seems unlikely.;
Oh, there’s definitely uncertainty out there, but I don’t view it as “political uncertainty,” which is what my comment was about.
I’m not certain how you’re seeing “a general anti-business sentiment.” I know that te MSM is conveying the meme that Obama is anti-business, but his actions in the health insurance reform, etc., don’t bear that out. Leaving aside Obama’s toothless rhetoric, we seem to be living through George W. Bush’s third term economically.
It’s not that the state has become incompetent in encouraging consumption, it’s that consumers are tapped out. They’re just not going to spend, particularly when their spending over the last decade has largely been done with borrowed funds, and they’re still saddled with that debt. This is why dumping all that money on the banks to prop them up was a useless effort, and why people are going to realize soon enough that Milton Friedman’s only remaining “valid” economic theory, that the Fed caused the Great Depression by not showering the banks with money, is just as invalid as all of the other bad economic theories he pushed.
As to your prescription, I think that is what’s needed for the long term, and I agree with you that we won’t see it happen in the short term. Further pain is needed to create the sense of urgency that it will take.
Tao,
“The American consumer is tapped out, all the multinationals who can offshore jobs (a euphimism for U.S. decapitalization) have done so, and to the extent that there’s any recover throughout the world, the multinationals are investing there. This is why we’re not seeing a real recovery in the U.S.”
I am not tapped out, I have alot of money I would like to throw around, and alot of things I would like to add to my asset list…….Why don’t I?….Because I can’t get a read on the near future, and typically when I get in situation where I don’t know what to do…….I don’t do anything!
Also,
If we can agree that the company’s who have been regulated/unioned out of the United States, don’t you think the obvious move, when looking for growth would be to offer some incentive to get them to come back? Have we seen or heard any of this behavior from the current leadership?……Hell No!
Jimi,
I am not tapped out, either. Far from it. But being in the top 0.5% of the population in terms of wealth and income, I realize that my personal situation is not indicative of the true state of affairs for the baseline American consumer.
Also like you, I would like to be doing more with my money, and the reason that I don’t is because I can’t get a read on the future, either, but I don’t lay blame at the feet of the government. (Again, I’ve NEVER said that there was not uncertainty, I’ve only challenged the notion that the government is the cause of that uncertainty.) The reason why I am uncertain is because of the obvious and rampant market manipulation by the big Wall Street players. Dark pools, hft, the flash crash, are all symptoms of the rigged casino that the equity markets have now become. But for the rigging of the system, I’d know exactly where things would be going (down).
The “regulated/unioned” phrase tells me that we are not quite agreeing on the problem because you seem to be buying into neoliberal ideology and blaming socialist democratic policies while I am laying the destruction of these businesses squarely at the feet of neoliberal policies that directly encourage the decapitalization of our country to the benefit of Walll Street and multinational corporations. The current “leadership” is no different than the last “leadership” when it comes to championing neoliberal policies, and the GOP’s vision of the solution, to the extent they seem to have one, also does not address the problem that we agree exists (regardless of what we think the cause is).
What I’d like to see is corporate taxes for U.S.-located (doesn’t matter if is a foreign investor) manufacturing and R&D houses set to zero and tax free repatriation of funds to form state banks that foster industrial development in their states. The idea is only half-baked, but the intent is to simultaneously revitalize the manufacturing sector while creating a banking system that is outside of competes with Wall Street to prevent.
Thank you Tao.
Tao,
Your comment is reasonable and of course we disagree in terms of correlation/causation. It really comes down to one’s perspective, because in reality it’s probably both. I just don’t see how we get to the conclusion that the reason everyone ran away was just for the benefit of Wall Street.
The other side is they ran away and Wall Street benefited, because the point of even being in buisness is profit, and when doing buisness in the United States becomes un-profitable, what did we expect them to do?
As far as whether current leadership, is just doing the same thing, with a different face…I don’t see it. People are afraid of how far the social agenda is going to go, and they are getting the vibe that the economic agenda is not about growth, but about re-distribution, and that has people stuck in their decision making, because anybody who actually has the slightest clue, understands what that agenda means over the long haul.
Wall Street ran America once before, and the Great Depression resulted. I know that it is hard to see how Wall Street is running America now, but that is because neoclassical economics ignores the presence and role of banks in the economy, and we’ve been conditioned in corporate America to believe that if it can’t be measured, it doesn’t exist. How can we bring ourselves to blame the banks for what is happening in our economy when banks don’t even exist in our economy (officiallly)?
The only redistribution that I see Obama engaged in is the same kind of redistribution that we’ve seen in every administration starting with Reagan: securing rents for corporate cartels (that’s exactly what happened with the health insurance “reform”). Yes, I know that Fox News, CNBC and a couple of other media outlets have done a great job in scaring white folk into believing that undeserving, deadbeat minorities are going to take their hard-earned property, but that’s part and parcel of GOP politics, whether it’s true or not. In Obama’s case, he is pretty convincing when he delivers his hopey-changey speeches, and I’m sure that can be scary, but he has shown time and again that the only change we can believe in or hope for is no change at all. Just as it was with Bush before him, you have to carefully compare what Obama actually does to what he said he was going to do. It’s all theater, and the media operates to make the fiction seem that more real.
Regardless, corporations are supposed to be run for the benefit of the shareholders. It’s their money that is being invested, not management’s, so whatever the personal fears of management, they should have no bearing on their business decision-making. There’s no “fear” line-item in the spreadsheet for the ROI analysis for new business investment. Fear isn’t measurable. Demand is, though, and there is no demand right now in the U.S.
Steve Keen explains how neoclassical economics masks the primacy of banking and finance in the real economy:
“What their blinkered ignorance of the role of the finance sector obscures is that the essential class conflict in financial capitalism is not between workers and capitalists, but between financial and industrial capital. The rising level of debt directly leads to a falling worker share of GDP, while leaving industrial capital’s share unaffected until the final collapse drives it too into oblivion.”
http://www.debtdeflation.com/blogs/2010/07/03/are-we-it-yet/
For months, my thesis has been that one of the primary reasons why the New Deal was possible was because the Great Depression lifted the veil from the industrial capitalists’ eyes: they realized they were better off throwing in their lot with labor and constraining the power of the banks to ensure that the banks were, like the rest of labor, the servants of capitalism and not its master.
All of the lies and frauds of Wall Street that led to the Great Depression have been replicated in effect but not form. Dark pools and high frequency trading, for example, replicate the pooling arrangements that sent false signals of supply and demand, falsely driving prices. Similarly, the derivatives markets created a mechansim for naked shorting, which was banned from the stock exchange. If you take the time to read through the Pecora Commission report, you can find direct analogs today of every manipulative, fraudulent practice of Wall Street in the 1920s.
The primary difference is that Wall Street learned how to control American industry as a mere shareholder, whereas before it relied upon interlocking boards of directors and access to credit. The only shareholders that really matter are the institutional holders, and the instiutional holders that matter most are Wall Street firms like Goldman Sachs (truly the smartest of the bunch, from my experience) and JPMorgan. Most of the major public companies boast institutional ownership of 75% or higher. Yes, a lot of these institutions are holding shares for the beneficial ownershp of somebody else, but the institutions are the only people management ever sees. So, tell me, when the corporate mantra is to “maximize shareholder value” and the only shareholder that matters is Wall Street (they’re the only ones who can get management bounced), who is in charge? The fact is that public companies are not run like privately owned businesses, they’re run to simulate a financial instrument that grows by a certain amount each year. While that’s impossible to do for very long, management is paid handomely for as long as they can maintain the illusion of promised perpetual growth.
Shouldn’t that be $1 trillion in excess reserves?
In the aggregate, yes, but I think the point of the statement was to establish a unit rate of interest per $1B in reserve. (25 basis points = .25% which translates to $2.5M in interest per $1B in reserves). Just multiply by a thousand to get the aggregate cost of interest payments.
Yes, It is a 1,000 billion, A trillion. A billion is just a rounding error these days…
jimi
i have been staying out because Tao knows more than i do. But if you think that either the unions or regulations are hurting American business you have been asleep or drunk for the past 30 years at least.
It just aint so.
add “redistribution” to the list of nightmare bogeymen that don’t exist in the real world.
Ktasting
rounding error: as it should be. we like to scare ourselves silly with Trillions, but it’s just a number. the kind of number you get with populations of 100 Million people making 50,000 dollars a year.
Silliest damn thing I ever saw was Sheiber and Shoven “The Real Deal” in which theyreport the “looming deficit” of Social Security as 20 TRiLLION DOLLARS!. Then they actually go to the trouble of showing that is only 2% of the 1,125 Trillion dollars in wages over the same time. But then they say, but still 2% of 1,125 Trillion is 20 Trillion and 20 Trillion is a Big Scary Number, so run around, scream and shout.
Because of course who would ever be so foolish as to think setting aside 2% of his wages to fund his longer expected retirement would be a sensible thing to do. Why, I know _I’d_ have a better use for 20 TRILLION DOLLARS !.
Just to note that in The Great Depression, as now, the banks did little or nothing to increase their books and stimulate growth. It happened without them:
http://www.asymptosis.com/wp-content/uploads/2009/03/bank-loans1-480×314.png
Dude, your constant slagging of Milton Friedman… especially the extreme ad-hominum of calling him a liar…. is highly, highly ignorant, and very much out of line.
Just to add: then, as now, it was probably due to lack of demand for loans as much as anything. Avalable cash for lending does *not* seem to be the problem facing the world economy.
If the excess interest is paid with Treasury securities, what’s the big deal?
Sure it adds to the deficit, but no current budgetary expense is paid.
Don Levit
Tao,
Meh….The Health Care conclusion is the mandate is going bankrupt insurance companies, and reduce the number of independent doctors…which falls right in line with Obama’s original statement…”I believe in The Single Payer System.”….and “I believe in The Single Payer System”………..is not a pro-capitalist agenda.
The Insurance Companies agree that in the beginning their balance sheet looks pretty good, but after full implementation and in the long run, they are pushed out, and that is exactly what the legislation was designed to do. Your entitled to beleive what you want, but there is no evidence that Obama is pro-buisness, especially if we assume he is driving the Bus behind the Cap & Trade Legislation.
I believed him when he said “We will bankrupt the coal companies.”
In my opinion, the reason why it seems that he is so pro-Wall Street is because he needs their help to apply the pain. But it looks like financial reform isn’t signaling that it protects Wall Street, it looks to me that opens the door for the Machine to pick the winners and losers. That isn’t pro-buisness in my book.
Coberly,
Everybody understands cheap labor is a driving force behind the big American Manufactures running away from American soil. But it isn’t the only reason.
Tell me why you think they all left? Because the labor may be cheap in a Third World Economy, but the slew of problems that comes along with it, isn’t cheap. Much more to the story than just cheap labor, which by the way does not exist in America when there is a one-on-one comparison of the final balance sheet.
TaoJonesing,
I agree with your analysis, very astute. Businesses shoud be quite certain that nothing will change under obama under tax law or anything else that could affect their profitability. This is not the cause of a lack of new investment. Anyway, they’ll probably give big biz a repatriation tax holiday under the guise of a neeed to increase investment in USA. The reason there is no investment and no gdp growth is that there is no demand for products from the great american consumer who’s credit fueled consumption is now quite over.
I agree that banks are largley insolvent and as such they aren’t properly valuig their assets or they’d show how broke they really are. The only creator of jobs in this economy if the fed gov and they need to put together a new industrialization program for the future or this country will continue down the path toward more inequity.
cjg
Have you got any valid data to support that comment? So we drop the label of liar and just be satisfied to accept that Friedman was a sycophant to corporate America, a shill who earned a good income producing unsupported economic theories that justified the worst examples of economic planning.
jimi, “Everybody understands cheap labor is a driving force behind the big American Manufactures running away from American soil. But it isn’t the only reason”
They’re not running from cheap labor. They’re scouring the Earth for the cheapest labor they can find and leaving a wide swath of destroyed communities in their wake. That’s business as usual, having no concern nor allegiance to the original country establishment of said business. Your comment is a bit confusing. You at one point seem to think that labor unions have chased business off shore. Good grief, Charlie Brown, workers want to earn a decent living. But at the next moment you point out that off shore, third world labor locations are frought with other problems, which you don’t enumerate.
So what do you think is the problem? Are American workers paid too lavishly? Is $50,000
a year outsized? How about $125,000? And what about those executive compensation pkgs that pay out a king’s ransom each and every several years?
Jack,
I think you mis-interpreted the comment. I intended to say, Manufacturing Was looking for Cheap Labor, not that it was the driving force to make them leave, but the driving force to entice them to go overseas.
“labor unions have chased business off shore.”
Well they have. I understand people need to make a decent living, but there is plenty of documentaion out there where American Manufacturing got in a situation where they were just not profitable in many of the union agreements they ended up with. [Retirement and Health Care cost went up, productiving went down]
“third world labor locations are frought with other problems, which you don’t enumerate”
Well many of the companies gained big time with cheap labor, but they had a huge investment up front in training, communications, access to natural resources, access to utilities needs etc..etc….etc.
The reason why it ends up being so profitable, and this all depends on the type of buisness it is…is because standrards, regulations, tax structure are so much less. Also the demands from the workers are less as far as productivity, retirement and health benefits, and depending on the culture that the company moved to they could really score big, even though they may have had to put in a massive initial investment to relocate.
“So what do you think is the problem?”
It is a combination of everything. Access to resources, Cost of Retirement and Health Beneifts, A regulatory situation that doesn’t focus on government wants only, and takes into account profitability, need for tort reform, less aggressive tax structure.
If we can’t figure a way to make everybody, maybe not happy, but happy enough so that companies are profitable and have the ability to grow while being able to grow the middle class into an upper middle class, then we should expect nothing better than the situation we have now. And I can tell you it will not happend by force! If any country knows how to make this all work on American soil it is us, this is in our blood, it’s just having to make the decision….Are we Free Market Capitalists or Not? Because…to be quite frank…. American Buisness does not have faith anymore that this country has the courage to be Free Market Capitalists.
Oddly I think paying interest on reserves was a good idea when the Fed started doing it. It was necessary to send money to banks. People hate banks. The Fed is able to resist popular opinion. The Fed was forcing banks to loan it money paying zero interest. Paying interest on your debts sure doesn’t seem excessively generous. It was necessary to recapitalize the banks. It all made sense as a transfer not as a relative price change aimed at changing behavior. I think this is why they did it and this is why they should stop as the bankers are no longer panicking. It sure wasn’t optimal policy (loaning at penalty interest rates is as noted by Ken when he used the number 1829). But it was better than a second great depression*.
I have never heard of this “economist.” I blame the WSJ for quoting him. He pretends not to believe in the market system and seems never to have heard of Hayek. You just can’t tell the effect of a change in the behavior of an economic agent assuming that all other economic agents keep on doing exactly the same thing. There is a market and a price system. If banks take the money which no longer pays interest and buy, say 3 month t-bills then the return on 3-month bills will go down. Even if the banks accept that low yield, other investors will switch to something a bit more risky (say 6 month t-bills) driving down that yield. And so on. So more money will go into relatively risky assets such as 3 year t-notes and corporate bonds.
Now Mr strawman might argue that this usually works, but at the moment, is pushing on a string, as safe short term interest rates are at the zero bound, so the Fed can’t lower them. Mr Strawman is especially strawy today. We are discussing whether the Fed should lower an interest rate which it pays. The interest rate on reserves is definitely not at the zero bound. Ken’s proposal is to get it there.
I think the fact that they are still doing it is just another case of interest group capture. It is hard for the Fed to stop, because banks sure like the income, most people don’t know about it, and the FED is insulated from public opinion but not at all from bankers. Obviously if something is good for banks at the expense of the rest of us, it is hard to stop the Fed from doing it. The Fed is limited by tradition and innovative responses to a crisis (that is Bernanke) have the cost that innovations which transfer money to banks will last forever while innovations which take money from them will last only as long as the crisis. I guess we should try to get the Fed to stop, but the odds aren’t great.
*Now the fed might have paid interests on reserves for a stupid reason. One rationale for doing so is the old lets lock the barn door after the horse escaped. Banks took too many risks. If the Fed had paid interest on reserves back during the bubble, banks would have born less risk (as a totally safe asset would have been more atractive). This is dumb, the bankers were terrified of risk when the Fed began paying interest on reserves. Bernanke is not dumb. I’m sure he just thought he had found a legal way to give money to banks at a time when he thought it was necessary and when people hated the idea (people always hate the idea).