The Myth of the “Credibility of Markets”
Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.
crossposted with New deal 2.0
The Myth of the “Credibility of Markets”
It is time to distinguish between the truths and the myths propagated by Wall Street.
A few days ago, I wrote a piece suggesting that President Obama’s attack on the proposed GOP threat to Social Security masked a more fundamental threat posed by members of his own party. Sadly, this analysis appears to be confirmed today in Mike Allen’s politico playbook:
“–ADMINISTRATION MINDMELD: The virtue of action on Social Security is that it demonstrates the ability to begin to affect the long-run deficits. Social Security isn’t the biggest contributor to the problem – that’s still health-care costs. But it could help a little bit, buy time, and strengthens the odds of a political consensus behind other spending cuts or tax increases. Most importantly, it would establish more CREDIBILITY with the MARKETS. The mood of the world at the moment (slightly excessive, from the administration’s point of view) is that if you don’t do anything with spending cuts, it doesn’t get you credibility.” (My emphasis).
This, in a word, encapsulates the Administration’s perverse Wall Street-centric thinking. Credibility with the American people takes a back seat to this amorphous concept called “the markets”, and the corresponding need to maintain “credibility”.
But how are we to divine the true aspirations of the markets? Is this really a legitimate basis for government policy? Private portfolio preference shifts (which are manifested daily in the capital markets) are probably the area least amenable to economic analysis. There are no cookie cutter models here (and economists LOVE models).
Consider the case of a currency: How does one respond to a weaker currency? The conventional response seems to be, “Raise interest rates and eventually you’ll re-attract the capital because you will re-establish ‘credibility’ with the markets”. That was essentially the IMF advice to East Asia in 1997. But, as that experience demonstrated, sometimes raising rates can actually trigger additional capital flight if it is perceived to be a panicked reaction to something. And Japan today clearly demonstrates that low rates per se do not necessarily prefigure a weaker currency. What does a 10 year Japanese government bond yielding less than 1% tell us about “the markets”? Does it reflect approval with a country that has a public debt to GDP ratio about 2.5 times higher than the US?
To paraphrase Milton (the poet, not Friedman), sometimes they also serve who only stand and wait!
Markets are an amorphous concept, which reflect heterogeneity of viewpoints. Some people today are buying gold because they foresee a Weimar style hyperinflation emerging in the face of all of this government spending. Some buy it because they envisage the death of fiat currencies and view the yellow metal as the ultimate insurance policy. Some invest because they consider gold the only real form of money. Some people view it as a barbarous relic and ignore it altogether. How does a government respond to these varying points of view? What’s the right policy response?
The myth that markets, not governments, ultimately determine rates has, of course, been legitimized to some degree by virtue of the fact that our institutional monetary arrangements still reflect archaic gold standard type thinking (whereby a certain amount of gold on hand was required to fund government operations). But we went off the gold standard decades ago. Still we have laws which mandate that all net government spending is matched $-for-$ by borrowing from the private market. So net spending appears to be “fully funded” (in the erroneous neo-liberal terminology) by the market. But in fact, all that is actually happening is that the Government is coincidentally draining the same amount from reserves as it adds to the banks each day and swapping cash in reserves for government paper.The resultant bond market drain is there to ensure that the central bank maintains control of its reserve rate. It has nothing to do with “funding” government operations itself.
If you think that sounds radical then consider the following question posed by my friend, Professor Bill Mitchell: If a government bond auction “fails” (i.e. the government doesn’t find enough buyers for the paper it issues during that particular sale), does this mean that your Social Security cheque is going to bounce? Will national infrastructure projects be suddenly halted because the net spending is not “funded”? Do we have to stop fighting a war in Afghanistan? The answer to all of these questions is the same: Of course not! The net spending will go wherever the Government intends it to go – after all the Government needs no funds to spend because it first creates the currency which is ultimately required to be spent in the real economy. The private sector does not produce dollars (if it did, it would represent a jailable offence called counterfeiting).
More fundamentally, how, pray tell, does one presume that the private sector can net save (in this case, dollars) something it cannot net produce?
Isn’t it true that the government is in a unique position because only it has the capacity to create new net financial assets? Now, granted, this simple observation does not readily apply to the euro zone because the individual countries concerned have effectively ceded that authority, thereby circumscribing an adequate fiscal response to their crisis (a point I have made before). But when the operations of government are examined in this light, it establishes that the Obama Administration’s ongoing fixation with “long term deficit reduction” and “establishing credibility with the markets” is as foolhardy as conducting human sacrifices to placate a deity.
Yet government policy responses today on issues like Social Security or Medicare reflect a misguided belief system and a genuine failure to understand the basis of modern money. Scaling back Social Security will certainly drive unemployment up higher than it is already going becomes it robs people of the very income required to sustain growth. Not a very sensible strategy if you truly care about implementing “change that people can believe in”.
Unfortunately, until these Wall Street-centric beliefs are fully exposed for the myths that they are, we can expect to see more dispiriting headlines of the sort reflected in Mike Allen’s latest politico playbook.
Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.
It is immoral to cut on 60% of spending which helps 100 million people. While ignoring 40% which is fra less effcient.
Medicare as a part of outlays is far less than DoD. Other entitlement categories are small compared to DoD.
The war machine consumes 20% of US government spending about equal to SS outlays.
That wasteful diversion of productive resources to war is a huge contributor to deficits. The resources go to killing and destroying, and are not very efficient in either.
GAO 09-326SP.
In my view worrying about credibility with the markets is not entirely misguided as markets are the determiner of capital movements and the primary creator of job growth. Public policy may propel economic activity but it is the market which will largely determine the direction, even in the case of housing, perhaps the most policy driven sector of the economy one can see the limits of policy input.
This is not to dispute the unfortunate ways that markets behave. Markets function as they do because they are both a reflection of our nature but they are also a reflection of the nature which we foster. There is a basis as to why markets are as dynamic as they are, they resonate deeply with who we are, but as one accepts this concept it becomes easy to excuse what markets do as an inevitable result of that. We are also social and herd animals that do respond to direction, and direction is what markets need. While keeping their inherent vitality it is possible to make them something that works toward our collective benefit.
One of the issues with our current type of financial markets strikes to the concept presented here that government is the sole creator of currency as so the only entity able fully fund its potential. This is not entirely true as it presents a tunnel vision of what constitutes currency. The trade in securities of various types negates this view. Even with a lack of sufficient hard currency to honor the liquidation value of all existing paper the value of that paper may be inflated. The financial sector is capable of increasing the size of balance sheets based upon paper created independent of the workings of the Fed or the Treasury, and in point of fact that is the basis of the problems associated with the sub prime crisis.
Is this good? Of course not. But we face the difficult decision to free the economy of what amounts to large areas dedicated to gambling on the value of paper assets at the expense of economic activity, remove this activity and it wont be replaced, the cure is a net loss plain and simple. That is especially difficult to do when faced with an economic adjustment of excessive consumption.
Rhodes
there is something sick about pandering to “the markets,” even if the markets create wealth as you say, they will do so in response to real “demand.” trying to goose them with government policy is ultimately going to fail, just like treating an illness with bleeding or stimulants.
the hell of it is, the “market fundamentalists” know this, and tell us this all the time. and yet they cannot help demanding the government “do something” to stimulate the markets.
but it’s worse than that.
“market credibility” is a sign that our President is a superstitious idiot. In the first place there isn’t a damn thing wrong with Social Security and it has nothing to do with the deficits. So what kind of credibility do you gain with the markets by cutting it? especially with the laughable excuse that it’s easier to cut than medical costs, and cutting it will somehow make it easier to cut medical costs.
oh, i forgot, somehow cutting Medicare is supposed to cut medical costs. the mechanism eludes me.
but it’s worse than that.
not so long ago the enemies of Social Security were telling people that “the bosses’ share” was “really the employees’ money.” This was to make the “return on investment” of Social Security look smaller and thereby make it look like a bad deal compared to “investing in the market.”
but that didn’t sell and the market doesn’t look as good as it did. So now all of a sudden they have discovered that the payroll tax is “really” a jobs killer. You see, if the bosses didn’t have to pay for Social Security (their share… or maybe your share too) they could afford to hire more people. Of course, if that’s “really” your money, what they are saying is that if they didn’t have to pay you enough to be able to afford to save for retirement, they could hire more people. They don’t talk about giving you “your” Social Security money to invest on your own. They talk about just not payig it at all.
And where does this suddenly popular idea come from. It comes from the people who are paid good money to think of magic jingles they can sell to simple minded people like Our President and Our Congress and all the Very Intelligent Businessmen to cut wages and increase profits.
Of course since they are only jingle makers, they don’t actually understand the cause and effect relatioinships that will lead to less profits in the long run. Something that will always happen when you impoverish the people.
Does capital or labor create wealth?
It is a mistake to take Mike Allen’s word for what happened in a closed-door meeting:
http://www.prospect.org/csnc/blogs/tapped_archive?month=08&year=2010&base_name=mike_allens_mindmismeld#121124
It is also a mistake to take seriously anyone who relies on Mike Allen to tell him what went on in such a meeting. It should mean a serious reputational loss to relate Mike Allen’s view on thinking within the Obama administration.
Seriously, Auerbach uses Allen to “confirm” Auerbach’s own view? Sad. Terrible. Outrageous. Mike Allen, for heaven’s sake.
it’s not the chicken nor the egg, ie capital or labor, rather it is DEMAND which comes about when consumers have money to spend. simply stated, the average joe or jane doesn’t earn enough or has been layed off. hence low demand & no business investment.
Rdan posted from Marshall Auerback:
The government needs no funds to spend because it first creates the currency which is ultimately required to be spent in the real economy.
That sounds like we need not be concerned about deficits.
Again, from Rdan’s posting Isn’t it true that the government is in a unique position because only it has the capacity to create new net financial assets?
Could you provide an example?
I thought the only one who could create something out of nothing was God.
Don Levit
Sorry Don
the answer is the same as last time: humans create something out of nothing all the time. as for God, well the research hasn’t been done yet.
either the government, or a banker, or just a man with an idea can create something out of nothing. either the government or a banker can create money out of nothing. money is only an idea.
essentially a recession is when the bankers run out of ideas. that’s when the government has to take over. if you have an enlightened government. if you have a government of people who listen to “the market,” then your government runs out of ideas at the same time.
Coberly:
If the federal government creates a Treasury security, it has to have a buyer.
Once it has a buyer, it creates an asset for the buyer, but a corresponding liability for the governemnt.
There is no net asset created.
Don Levit
well Don
it’s a good thing you are not the worlds money manager. you don’t understand what money is.
if the united states sells a bond to someone for cash, it can use the cash for buying goods and services that the people want. and the buyer of the bond has an asset he can sell in the marketplace, or hold and collect interest from the “profits” the government makes on the money it borrowed. those profits come in the form of rising wealth of the people out of which they pay increased taxes.
this is exactly what banks have done since before there were effective governments. you see, the “money” is in effect created out of thin air, though for centuries people had to believe there was some “gold” behind the iou’s issued by the banker (merchant), so they were sure they could get their money back. of course there was never as much gold as there was iou’s. the bank relied on not everyone asking for their money back at the same time. and often lost this bet. leading to economic dislocations, and certainly a lot of unhappy people.
governments do the same thing, only they are in a better position to “guarantee” their money because you can always pay your taxes with it. of course when people lose faith in the value of government money, that can cause economic dislocations. but in the end it’s all a matter of faith, not of some hard real substance that can’t be created out of nothing.
oh, back to the original banks. they lent out the money they borrowed, maybe more than they borrowed, so people would use the money to buy the stuff they needed to run their business and make more money and pay back the bank plus interest.
it’s called capitalism. you ought to look it up.
i forgot to mention, what the government does with the money it borrows (or taxes, or prints… effectively borrowing from the future) is theoretically supposed to make it easier for the people to get richer. whether that is building roads, or even guns to keep the world’s bad guys from coming in and taking over your farm), so, yes, the government does “create” value.
what we may be seeing to day is a government whose policies are not making us richer. though they may be making the rich richer. which is what happened in France leading up to 1789.
Coberly:
I agree with everything you said, but you left out one important point.
It is an asset to the holder of the Treasury, but it is also a liability to the Treasury, so it is, in a sense, a wash – neither an asset nor a liability.
The same dynamic occurs when Treasury borrows from the trust funds.
Don Levit
There are few things the modern American financial market despises more than someone who actually does something that creates jobs in the United States. This is true in other businesses as well. Walmart has for years pressured suppliers to ship all of their manufacturing overseas and abandon quality in the process as long as it shaves costs. An acquaintance who lived in Silicon Valley for years and worked in the tech field told me that the modern VC isn’t going to fund anyone who won’t be willing to outsource as much as possible as soon as possible. I don’t know how accurate it is but it fits in with the mentality that rewards publicly held companies every time they eliminate jobs, especially in the U.S.
actually Don
it’s a win win.
the person who has the money wanted that more than he wants the money it will take him to repay the debt. the person who has the bond wants the future money more than the money that he gave for the bond. so they are each better off than they were without the deal.
ERhoades: “In my view worrying about credibility with the markets is not entirely misguided as markets are the determiner of capital movements and the primary creator of job growth.”
I agree that that is a factor to consider. But right now two things are going on. First, people are being told that we **need** the markets to finance the gov’t. We do not. Second, people are being told that the markets are concerned with the debt and deficits. But take a look at what is happening with market movements and the news. When there is bad news on unemployment the markets tank. What does that tell us about credibility with the markets? That we will gain credibility by reducing unemployment, n’est-ce pas? Yet both the Fed and the Congress (along with the White House) are making token gestures, without any expectation of bringing unemployment down to reasonable levels in a reasonable amount of time. A real jobs bill would help to restore credibility with the markets, no?
“Does capital or labor create wealth?”
False dichotomy. People create wealth.
coberly : “somehow cutting Medicare is supposed to cut medical costs. the mechanism eludes me.”
Easy. Cutting Medicare means that many old people will die sooner. Since up to half of medical costs come in the last 6 months of life, reducing life expectancy by, say, 3 months will save a lot of money.
😉
Oh, and cutting Medicare will mean that the market decides who lives or dies. We don’t want any Death Panels. The market knows best.
Don Levit: “The government needs no funds to spend because it first creates the currency which is ultimately required to be spent in the real economy.
“That sounds like we need not be concerned about deficits.”
It may sound that way, but that is not the case. We should be concerned about deficits under some circumstances, but not when the unemployment rate is almost 10% and the economy is limping along, with deflation a real threat.
coberly: “ either the government or a banker can create money out of nothing. money is only an idea. “
The banker, however, must create an equal debt at the same time as it creates money. The gov’t does not have to do so. (Although the way we have set things up, it does, except for coinage and printing currency.) However, the gov’t can roll over its debt indefinitely, or issue money without the debt, like Lincoln did.
Min
off the top of my head: when the government creates money without creating a specific debt, it creates a debt from the economy in general to the future. same prinicple. probably even easier to collect than sending over vinnie and luigi.
coberly: “ when the government creates money without creating a specific debt, it creates a debt from the economy in general to the future.”
OK, suppose that the gov’t simply creates money for the $26 billion aid to the states that was recently appropriated. Say it writes the checks, but when they come back to the Fed it does not debit the Treasury account. Where is this “debt . . . to the future”? Thanks. 🙂