naked capitalism

By George Washington of Washington’s Blog.

Preface: My apologies if this is offensive.  As always, Yves Smith is not responsible for this content, does not necessarily agree, sponsor or endorse it.

Many people have called politicians prostitutes.

True, Obama has received more donations from Goldman Sachs and the rest of the financial industry than almost anyone else.

And Summers and the rest of Obama’s economic team have made many millions – even recently – from the financial industry.

And Congress has largely been bought and paid for, and two powerful congressmen have said that banks run Congress.

So yes, they have certainly sold their goods to the highest bidders.

Indeed, at least some people trust prostitutes more than elected officials.

But the prostitution analogy is inaccurate.

Specifically, as the chairman of the Department of Economics at George Mason University (Donald J. Boudreaux) points out:

Real whores, after all, personally supply the services their customers seek. Prostitutes do not steal; their customers pay them voluntarily. And their customers pay only with money belonging to these customers.

In contrast, members of Congress routinely truck and barter with other people’s property…

Members of Congress are less like whores than they are like pimps for persons unwillingly conscripted to perform unpleasant services.

Consider, for example, agricultural subsidies. Each year a handful of farmers and agribusinesses receive billions of taxpayer dollars. These are dollars that government forcibly takes from the pockets of taxpayers and then transfers to farmers.

The customers, in this case, are the farmers and agribusinesses. The suppliers of the services performed for these customers are taxpayers, for it’s the taxpayers who possess the ultimate asset — money — that farmers and agribusinesses lust after. And the intermediaries who oblige the suppliers to satisfy the base lusts of the customers are politicians. Just as pimps facilitate their customers’ access to prostitutes’ assets, politicians facilitate their customers’ access to taxpayers’ assets.

We taxpayers have less say in the matter than we like to think. Sure, we can vote. But if even just 50.00001 percent of voters cast their ballots for the candidate proposing higher taxes, the assets of not only our pro-tax citizens, but also those of the remaining 49.00009 percent of us anti-tax citizens are put at the disposal of our pimps’ customers. (And note that many of those who vote for higher taxes are not among those persons actually subject to higher taxation)…

Politicians force taxpayers to pony it up — just as the services rendered for a pimp’s customers are rendered not by that pimp personally, but by the ladies under his charge. The pimp pockets the bulk of each payment; he’s pleased with the transaction. His customer gets serviced well in return; he’s pleased with the transaction. The only loser is the prostitute forced to share her precious assets with strangers whom she doesn’t particularly care for and who care nothing for her.Also like the ladies under pimps’ power, taxpayers who resist being exploited risk serious consequences to their persons and pocketbooks. Uncle Sam doesn’t treat kindly taxpayers who try to avoid the obligations that he assigns to them. Government is a great deal more powerful, and often nastier, than is the typical taxpayer. Practically speaking, the taxpayer has little choice but to perform as government demands.

So to call politicians “whores” is to unduly insult women who either choose or who are forced into the profession of prostitution. These women aggress against no one; like all other respectable human beings, they do their best to get by as well as they can without violating other people’s rights.

The real villains in the prostitution arena are those pimps who coerce women into satisfying the lusts of strangers. Such pimps pocket most of the gains earned by the toil and risks involuntarily imposed upon the prostitutes they control. No one thinks this arrangement is fair or justified. No one gives pimps the title of “Honorable.” Decent people don’t care what pimps think or suppose that pimps have any special insights into what is good or bad for the women under their command. Decent people don’t pretend that pimps act chiefly for the benefit of their prostitutes. Decent people believe that pimps should be in prison.

Yet Americans continue to imagine that the typical representative or senator is an upstanding citizen, a human being worthy of being feted and listened to as if he or she possesses some unusually high moral or intellectual stature.

It’s closer to the truth to see politicians as pimps who force ordinary men and women to pony up freedoms and assets for the benefit of clients we call “special-interest groups.”

Note: There are a handful of honest politicians, fighting for the American people. But the exception proves the rule.

By George Washington of Washington’s Blog.

Ron Paul tells Bloomberg that Congressman Watt has just more or less killed the bill to audit the fed:

Representative Ron Paul, the Texas Republican who has called for an end to the Federal Reserve, said legislation he introduced to audit monetary policy has been “gutted” while moving toward a possible vote in the Democratic-controlled House.

The bill, with 308 co-sponsors, has been stripped of provisions that would remove Fed exemptions from audits of transactions with foreign central banks, monetary policy deliberations, transactions made under the direction of the Federal Open Market Committee and communications between the Board, the reserve banks and staff, Paul said today.

“There’s nothing left, it’s been gutted,” he said in a telephone interview. “This is not a partisan issue. People all over the country want to know what the Fed is up to, and this legislation was supposed to help them do that.”..

Paul, a member of the House Financial Services Committee, said Mel Watt, a Democrat from North Carolina, has eliminated “just about everything” while preparing the legislation for formal consideration. Watt is chairman of the panel’s domestic monetary policy and technology subcommittee.

Congress is also suggesting that the Fed be given more powers, making it the chief risk regulator of the entire banking system.

Specifically, as summarized by Huffington Post, a new bill introduced by Democrats in Congress “gives the Federal Reserve the power to determine which firms are actually ‘too big to fail’ and pose systemic risk to the financial system.”

Given the Fed’s history (as discussed below), that is like appointing the head of the Medellin drug cartel as drug tzar.

Admittedly, the Congressional bill allows other agencies a seat at the risk regulator table. But those are likely token seats. If the drug tzar’s office was staffed by the head of the Medellin drug cartel – who had the majority vote – and some law enforcement officers who have a history of either (a) being on the take or (b) looking the other way, what do you think would the result would be?

High-Level Fed Officials Speak Out

High-level officials of the Fed itself have criticized the Fed’s actions. For example, the head of the Federal Reserve bank of San Francisco – during a talk on how runaway bubbles can lead to depressions – admitted:

Fed monetary policy may also have contributed to the U.S. credit boom and the associated house price bubble …

Fed Vice Chairman Donald Kohn conceded that the government’s actions “will reduce [companies'] incentive to be careful in the future.” In other words, he’s admitting that the government’s actions will encourage financial companies to make even riskier gambles in the future.

Kansas City Fed President and veteran Fed official Thomas Hoenig said:

Too big has failed….

The sequence of [the government's] actions, unfortunately, has added to market uncertainty. Investors are understandably watching to see which institutions will receive public money and survive as wards of the state…

Any financial crisis leaves a stream of losses among the various participants, and these losses must ultimately be borne by someone. To start the resolution process, management responsible for the problems must be replaced and the losses identified and taken. Until these actions are taken, there is little chance to restore market confidence and get credit markets flowing. It is not a question of avoiding these losses, but one of how soon we will take them and get on to the process of recovery….

Many of the [government's current policy revolves around the idea of] “too big to fail” …. History, however, may show us a different experience. When examining previous financial crises, both in other countries as well as the United States, large institutions have been allowed to fail. Banking authorities have been successful in placing new and more responsible managers and directions in charge and then reprivatizing them. There is also evidence suggesting that countries that have tried to avoid taking such steps have been much slower to recover, and the ultimate cost to taxpayers has been larger…

The current head of the Philadelphia fed bank, Charles Plosser, disagrees with Bernanke’s strategy of the endless printing-press and ever-increasing fed balance sheet:

Plosser urged the Fed to “proceed with caution” with the new policy. Others outside the Fed are much more strident and want plans in place immediately to reverse it. They believe an inflation storm is already in train.***

Bernanke argued that focusing on the size of the balance sheet misses the point, arguing the Fed’s various asset purchase programs are not easily summarized in a single number.

But Plosser said that the growth of the Fed’s balance sheet was a key metric.

“It is not appropriate to ignore quantitative metrics in this new policy environment,” Plosser said.***

Plosser is bringing the spotlight right back to the Fed’s balance sheet.

“The size of the balance sheet does offer a possible nominal anchor for monitoring the volume of our liquidity provisions,” Plosser said.

The former head of the Fed’s Open Market Operations says the bailout might make things worse. Specifically, the former head of the Fed’s open market operation – the key Fed agency which has been loaning hundreds of billions of dollars to Wall Street companies and banks – was quoted in Bloomberg as saying:

“Every time you tinker with this delicate system even small changes can create big ripples,” said Dino Kos, former head of the New York Fed’s open-market operations . . . “This is the impossible situation they are in. The risks are that the government’s $700 billion purchase of assets disturbs markets even more.”

And William Poole, who recently left his post as president of the St. Louis Fed, is essentially calling Bernanke a communist:

Poole said he was very concerned that the Fed could simply lend money to anyone, without constraint.

In the Soviet Union and Eastern Europe during the Cold War era, economies were inefficient because they had a soft-budget constraint. If a firm got into trouble, the banking system would give them more money, Poole said.

The current situation at the Fed seems eerily similar, he said.

“What is discipline – where are the hard choices – when does Fed say our resources are exhausted?” Poole asked.

But the strongest criticism may be from the former Vice President of Dallas Federal Reserve, who said that the failure of the government to provide more information about the bailout could signal corruption. As ABC writes:

Gerald O’Driscoll, a former vice president at the Federal Reserve Bank of Dallas and a senior fellow at the Cato Institute, a libertarian think tank, said he worried that the failure of the government to provide more information about its rescue spending could signal corruption.

“Nontransparency in government programs is always associated with corruption in other countries, so I don’t see why it wouldn’t be here,” he said.

Of course, former Fed chairman Paul Volcker has also strongly criticized current Fed policies.

Global Agencies Speak Out

BIS – the central banks’ central bank – slammed the Fed and other central banks for blowing bubbles and then “using gimmicks and palliatives” which “will only make things worse”.

The head of the World Bank also says:

Central banks [including the Fed] failed to address risks building in the new economy. They seemingly mastered product price inflation in the 1980s, but most decided that asset price bubbles were difficult to identify and to restrain with monetary policy. They argued that damage to the ‘real economy’ of jobs, production, savings, and consumption could be contained once bubbles burst, through aggressive easing of interest rates. They turned out to be wrong.

Economists Speak Out

Stephen Roach (former chief economist for Morgan Stanley, and now director of Morgan Stanley Asia) is one of the most influential and respected American economists.

Roach told Charlie Rose this week that we have had terrible Federal Reserve policy for the past 12 years under Greenspan and Bernanke, that they concocted hair-brained theories (for example, that we should let the boom and bust cycle occur, but then “clean up the mess” once things fall apart), and that we really need to reform the Fed.

Specifically, here’s the must-read portion of the interview:

STEPHEN ROACH: And what’s missing in the debate that drives me nuts is going back to the very function of central banking that’s at the core of our financial system. Do we have the right model for the Fed to go forward? And, you know, I think we’ve minimized the role that the custodians, the stewards of our financial
system, the Federal Reserve, played in leading to this crisis and in making sure that we will never have this again. I think we’ve had horrible central banking in the United States for the past dozen of years. I mean, we elevate our central bankers, we probably .

CHARLIE ROSE: From Greenspan to Bernanke.

STEPHEN ROACH: Yeah.

CHARLIE ROSE: Both.

STEPHEN ROACH: We call them maestro, and, you know, we make them
sound larger than life. And, you know, and the fact is, they condoned
policies that took us from one bubble to another. They failed to live up
to their regulatory responsibility granted them by law. They concocted new
theories to explain why these things could go on forever, and they harbored
the belief, mistakenly in my view, that monetary policy is too big and
blunt an instrument, and so you just bring it in to clean up the mess
afterwards rather than prevent a mess ahead of time. Well, look at the
mess we’re in right now. We need a different approach here. We really do.

Leading economist Anna Schwartz, co-author of the leading book on the Great Depression with Milton Friedman, told the Wall Street journal that the Fed’s entire strategy in dealing with the financial crisis is wrong. Specifically, the Fed is treating it as a liquidity problem, when it is really an insolvency crisis.

Moreover, prominent Wall Street economist Henry Kaufman says that the Federal Reserve is primarily to blame for the financial crisis:

“I am convinced that the misbehavior of some would have been much rarer — and far less damaging to our economy — if the Federal Reserve and, to a lesser extent, other supervisory authorities, had measured up to their responsibilities …

Kaufman directly criticized former Federal Reserve Chairman Alan Greenspan for not using his position to dissuade big banks and others from taking big risks.

“Alan Greenspan spoke about irrational exuberance only as a theoretical concept, not as a warning to the market to curb excessive behavior,” Kaufman said. “It is difficult to believe that recourse to moral suasion by a Fed chairman would be ineffective.”

Partly because the Fed did not strongly oppose the repeal in 1999 of the Depression-era Glass-Steagall Act, more large financial conglomerates that were “too big to fail” have formed, Kaufman said, citing a factor that has made the global credit crisis especially acute.

“Financial conglomerates have become more and more opaque, especially about their massive off-balance-sheet activities,” he said. “The Fed failed to rein in the problem.”…

“Much of the recent extreme financial behavior is rooted in faulty monetary policies,” he said. “Poor policies encourage excessive risk taking.”

Economist Marc Faber says that central bankers are money printers who create bubbles, and that the system would be much better now if the Fed hadn’t intervened. Specifically, Faber says that – if the Fed hadn’t intervened – the system would be cleaned out, the system would be healthier because debt load and burden on taxpayers would be reduced.

Economist Jane D’Arista has shown that the Fed has failed miserably at its main task: providing a “counter-cyclical” influence (that is, taking the punch bowl away before the party gets too wild).

The Fed has also failed miserably in its role as regulator of banks and their affiliates. As well-known economist James Galbraith says:

The Federal Reserve has never been an effective regulator for the straightforward reason that it is dominated by economists and bankers and not by dedicated skeptics who make bank regulation a full-time profession.

The Fed has performed terribly in many other tasks as well.

And the Fed is unlawfully refusing to disclose to Congress or the American people who it’s giving money to and what it is really doing.

Conclusion

Given the above, isn’t it obvious that Congress is attempting to give the Fed more powers at a time when it should be audited, and then ended?

California among 15 states suing Amgen over anemia drug Los Angeles Times

Bad C’s Michael Panzner

Hampton Georgia (Pop. 5,300) Attacked by FDIC, FHA, Fannie and Freddie Bruce Krasting

EU competition commission foists draconian remedies on RBS Telegraph (hat tip Swedish Lex)

Shock and Awe The Epicurean Dealmaker

Antidote du jour:

You get an antidote from the antidote:

By George Washington of Washington’s Blog.

Preface:  Please read to the end to see the humorous quote.

I have previously debunked numerous false arguments used to defend the too big to fails. See this and this.

But the apologists for the TBTFs are now arguing that breaking up the beached whales … er, giant banks … will harm America’s ability to compete with foreign banks.

Joshua Rosner (managing director of an independent financial services research firm), has written an important essay debunking this argument:

Those who argue against a more proactive reduction in risk and size of TBTF institutions will, as always, revert to an argument that strikes a natural chord in every American’s heart: ‘Doing so would create an unleveled international playing field for our institutions relative to their international competitors’. Level playing fields are a worthy goal, but this is not a relevant argument. Instead, this tired bromide must be resoundingly dismissed on several counts:

• Those countries with the largest banks as a percentage of GDP (Iceland, Ireland, Switzerland) demonstrated that a concentration of banking power can cause significant sovereign risk and tilt global economic playing fields away from that country.

• The likely breakups of ING, Lloyds and KBC suggest that it is we who seek to support an unlevel playing field where we subsidize our TBTF banks while other nations recognize the policy failures of moral hazard. If we continue down this path we will likely be at risk of violating international fair trade regimes.

• When the “unlevel playing field” argument is cited, keep in mind this reasoning supports the disadvantaging of 8000+ community banks relative to our largest banks, all in the name of protecting big banks from governmentally- subsidized international competition.

• There is no longer any evidence that, beyond a cost of capital advantage that comes with implied government support, there are sustainable and tangible economies of scale arising from being the largest. The financial supermarket concept has been proven a failure. The only ones who benefit are the high-level executives.

• We must demand that our legislators no longer allow unelected officials at the independent Federal Reserve to sign international accords created by the TBTF banks through supra-national bodies like the Basel Committee.

• Are we to believe that if we did not have such large and globally dominant firms, US borrowers might be paying more that the 29% interest that several of the TBTF firms are now charging on their card accounts? Perhaps we should think about what advantage our population has gained as a result of our financial institutions being such a large part of our economy or being globally dominant.

• Since when did we accept a national strategy of following rather than leading? When we do what is right, others follow. As example, consider the bank secrecy havens – they made money for a bit. Now, even the Swiss and the Cayman authorities are coming around to our view.

• We are already at a disadvantage given that the largest foreign banks operate in the US without any tier one capital requirement and yet mostlarge foreign banks have not built a bricks and mortar presence here. Nobody screams about their undercapitalization nor has that undercapitalization caused deposits to migrate to foreign banks.

What fake excuse will the apologists for the TBTFs throw out next?

That breaking up the giants and letting small and mid-sized banks, credit unions and state public banks compete fairly will shift the Earth’s gravitational field as deposits shift away from the money centers?

Note: Rosner has a funny and potentially effective idea for putting pressure on Congress. He suggests that we all call our representatives and ask how much the lobbyists have paid them to destroy America’s economy by propping up the too big to fail banks.

Rosner’s actual language is somewhat over-the-top:

The Value of the “Too Big to Fail” Big Bank Subsidy Dean Baker and Travis McArthur

Congress and TBTF – Bring in the Bomb Squad Josh Rosner (hat tip reader John Bougearel)

Antidote du jour:

Harper’s Magazine has written up the lengths to which the authorities will go in censoring views that dissent with what is the unstated official policy: that no demand of the banking industry is too unreasonable not to be catered to.

The object lesson is the gutting of the falsely-branded derivatives reform bill. It arrived with a loophole so large you could drive a truck through it, namely that customized derivatives were not covered. So this bill will do nothing to impede the growth of complex opaque products; in fact, it encourages it, since banks will have no oversight if they tweak a product so that is can be deemed “customized.” It was further weakened by excluding most of the banks in America and by excluding a whole swathe of end users. The final insult was making the derivatives clearing house self-regulating.

The hearings on the bill had testimony scheduled only from what amounted to industry flacks. Someone apparently realized at the 11th hour that that might not go over with the correctly angry public too well. So less than 24 hours prior to the session before the House Financial Services Committee, an invitation was issued to Rob Johnson, a former managing director at Bankers Trust Company and former economist at the Senate Banking Committee and Senate Budget Committee.

So what transpired? As Ken Silverstein recounts:

Johnson, who came last, offered the only serious critical viewpoint… After about five minutes of his testimony, Congresswoman Melissa Bean—another industry-funded committee member who chaired the hearing because Frank was absent—had heard enough. “I’m just going to ask you to wrap up because we’re running out of time,” she told Johnson.

Johnson gamely continued. “When I hear the testimony today that are largely financial institutions and end users, I believe that I represent a third group that comes to the table, which is the taxpayers, the working people of the United States,” he said.

“I do need a final comment,” Bean interjected seconds later.

That put an end to Johnson’s testimony. “I was just called to this hearing last night, so I will provide detailed comments on your bill and a statement for the record that will finish my comments,” he concluded.

So what happens next? >The House Financial Services Committee has refused to publish his testimony, offering “the dog ate my homework” level excuses, first that they hadn’t gotten it, then that it was in the wrong format, then that their IT department was experiencing difficulties (always a good one when real reasons are running thin). The last one was pure Catch-22: that he had gotten his written testimony in too late.

You can read his statement, which is obviously too offensive to powerful interests for it to see the light of day in any officially-sanctioned venue, at the Roosevelt Institute.

By George Washington of Washington’s Blog.

When a liberal labor leader and a conservative financial policy analyst unite against something, you know that something is really bad (actually, I don’t believe in the whole false left-right dichotomy; I think its Americans versus those trying to steal our wallets and our rights, but that’s another story).

Today, AFL-CIO president Richard Trumka has slammed the Fed and the proposed “Tarp on steroids” legislation in his testimony to Congress today. Here are the must-read parts of Trumka’s prepared remarks to the House Financial Services Committee:

We are deeply concerned that the Committee’s work thus far on the fundamental issues of regulating shadow financial markets and institutions will allow the very practices that led to the financial crisis to continue. The loopholes in the derivatives bill and the failure to require any public disclosures by hedge funds and private equity funds fundamentally will leave the shadow markets in the shadows. We urge the Committee to work with the leadership to strengthen these bills before they come to the House floor.

However, these powers must be given to a fully public body, and one that is able to
benefit from the information and perspective of the routine regulators of the financial system. We believe a new agency, with a board made up of a mixture of the heads of the routine regulators and direct Presidential appointees would be the best structure. However, if the Federal Reserve were made a fully public body, it would be an acceptable alternative.

But we cannot support the discussion draft made public earlier this week because it gives dramatic new powers to the Federal Reserve without reforming its governance so that the banks themselves are removed from the governance of the Federal Reserve System. Even more alarmingly, the discussion draft would appear to give power to the Federal Reserve to preempt a wide range of rules regulating the capital markets—power which could be used to gut investor and consumer protections. If this Committee wishes to give more power to the Federal Reserve, it must make clear this power is only to strengthen safety and soundness regulation and it must simultaneously reform the Federal Reserve’s governance. Reform cannot be put off until another day.

The Federal Reserve currently is the regulator for bank holding companies. In that
capacity, it was responsible throughout the period of the bubble for regulating the parent companies of the nation’s largest banks. While regulatory authority rests in the Board of Governors of the Federal Reserve in Washington, routine responsibility for regulatory oversight has been delegated by the Board of Governors to the regional Federal Reserve Banks. The Federal Reserve System’s regulatory expertise resides in these regional banks.

The problem is that these regional Federal Reserve Banks are actually controlled by their member banks—the very banks whose holding companies the Fed regulates. The member banks control the selection of the majority of the regional bank boards, and the boards pick the regional bank presidents, who are effectively the CEO’s of the regulatory staff.

These arrangements may explain why the Federal Reserve has never given any account of how it allowed bank holding companies like Citigroup and Bank of America to arrive at a point where they required tens of billions of dollars of direct equity infusions from the public purse to avoid bankruptcy.

Giving the Federal Reserve with its current governance control over which financial
institutions are bailed out in a crisis is effectively giving the banks the ability to raid the Treasury for their own benefit.

We are also deeply troubled by provisions in the discussion draft that would allow the Federal Reserve to use taxpayer funds to rescue failing banks, and then bill other nonfailing banks for the costs. The incentive structure created by this system seems likely to increase systemic risk.

We believe it would be more appropriate to require financial institutions to pay into an insurance fund on an ongoing basis. Financial institutions should be subject to progressively higher fee assessments, and stricter capital requirements, as they get larger. This would be a way of actually discouraging “too big to fail.”

In addition, language in the draft that appears to limit taxpayer bailouts of bank
stockholders actually does no such thing, rather it simply ensures that when stockholders are rescued with public funds, bondholders and other creditors are rescued with them…

Finally, and not least, the discussion draft appears to envision a process for identifying and regulating systemically significant institutions, and for resolving failing institutions, that is secretive and optional—in other words, the Federal Reserve could choose to take no steps to strengthen the safety and soundness regulation of systemically significant institutions. In these respects, the discussion draft appears to take the most problematic and unpopular aspects of the TARP and makes them the model for permanent legislation.

Instead of repeating and deepening the mistakes associated with the bank bailout,
Congress should be looking to create transparent, fully publicly accountable mechanisms for regulating systemic risk and for acting to protect our economy in any future financial crises.

Conservative Peter Wallison – financial policy study analyst at the American Enterprise Institute – largely agrees. In his prepared remarks to Congress, Wallison says:

The Discussion Draft of October 27 contains an extremely troubling set of proposals which, if adopted, will bring economic growth in this country to a standstill, essentially turn over the control of the financial system to the government, and seriously impair competition in all areas of finance.

Rather than ending too big to fail, the Draft makes it national policy. By designating certain companies for special prudential regulation, the Draft would signal to the markets that these companies are too big to fail, creating Fannies and Freddies in every sector of the economy where they are designated. This will impair competition by giving large companies funding and other advantages over small ones.

The idea that the designation of these companies will be kept secret is, with all due respect, absurd; securities laws alone will require them to disclose their special status; simple truthfulness will do the rest…

If this legislation is passed, every industry will be in Washington, asking for special treatment or exemption. Competition in the market will become competition before this committee or in the halls of the Fed, lobbyist-to-lobbyist and lawyer-to-lawyer…

This will not only create uncertainty and moral hazard, but it will give the large and powerful companies special advantages over small ones. Those that seem likely to be taken over by the government will have easier access to credit, at lower rates, than those likely to be sent to bankruptcy.

In other words, the Draft proposes nothing more or less than a permanent TARP, using government money to bail out the large or politically favored companies, and then taxes the remaining healthy companies to reimburse the government for its costs of competing with them…

The [proposed bill] would take control of the financial industry in the United States, stifle risk-taking and initiative, and change competitive conditions in every sector of the economy so that they favor large, government-backed, too big to fail enterprises…

The Draft … would now give the Fed authority to regulate any financial company that the Council determines should be subject to “heightened prudential standards,” even if there is no insured bank in the group…

The result is that the question becomes one of political clout, with industries fighting in Congress for the competitive result they want. Some industries want to invade others’ turf; the invaded industry uses the law to fend off the competition; consumers are the losers. Congress becomes the battleground. It’s not just unseemly; it’s a frightening example of what happens when the government starts picking winners…

Congress will be injecting itself into competitive fights between firms and industries, further politicizing what should be economic or financial decisions…

The Designated Companies are under the complete control of the Fed. They will not be able to initiate new activities without the Fed’s approval, or enter new competitive fields, or perhaps even open new offices in new places. This is a degree of political control of business that has never been attempted before. Not only will it place the dead hand of government on the activities of financial companies, but it will almost certainly drive many financial companies out of the United States before they submit to these restrictions.

The effect of these restrictions for the U.S. economy will be dire. First, Designated Companies will clearly have been labeled as too big to fail. In effect, the government has notified the capital markets that these firms will not be allowed to go into bankruptcy—they will be rescued in the ways I will describe below. This means they will be less risky borrowers than smaller companies that are not going to be controlled in the same way. As less risky borrowers, the Designated Companies will have lower costs of funding and will be able to drive smaller competitors from the markets they enter. Sound familiar? Yes, it’s Fannie Mae and Freddie Mac all over again. The existence of these Designated Companies will impair competition in every market they are allowed to enter, and will force the consolidation of competitors so that markets become dominated by government-backed giants like themselves….

[The bill assumes that] our entire financial system must be subjected, today, to far-reaching control by the Federal Reserve Board. With all due respect, this is absurd, and certainly disastrous for economic growth in the future.

The Draft also contains language that suggest some of the problems of identifying Designated Companies in advance—and thus creating the Fannie/Freddie too big to fail problem—can be avoided if the designation of these companies is not disclosed to the public. This, too, with all due respect, is absurd…

In addition, there is very little incentive for the government not to rescue failing Designated Companies, because the Draft provides that the surviving members of the financial industry larger than $10 billion in assets—whether Designated Companies or not—will be taxed to reimburse the government for its costs in the bailout…

As in the GM and Chrysler bailouts, preferences are going to go to favored groups, and disfavored groups will suffer disproportionate losses. It will be a political free for all, with important legislators pressing the FDIC to treat their constituents better than someone else’s constituents.

What we know is that no losses will be taken immediately by creditors. This is because the objective of the resolution authority is to prevent a “disorderly” failure, which actually means a failure in which creditors suffer immediate losses…

The proposals in the Draft reflect very bad policy—far more likely to be destructive of the financial system and damaging to the economy than an improvement on what exists today.

New Name Floated In Geithner Replacement Talks Dealbreaker (What up, bankster? I said I wouldn’t be using that word but it’s in context and I had to say it. This will be the new Treasury lyrical theme – just replace the word gangsta with the other one.)

America’s Next President? YouTube (Oops. wrong link at first. In the same vein as the last link. Hat tip Andrew Sullivan)

Galleon paid banks millions for ‘edge’ FT (Proof the system is rigged)

How to avoid a repeat of the Great Crash FT

Struggling in a recovering economy BBC

Soros: General Theory of Reflexivity FT (Not much chatter on this yet. Hat tip reader Scott)

What if George W. Bush had done that? Politico

The Presidency and The Rise of the New Partisan Press Balkinization (Hat tip reader Scott)

North Carolina Sea Levels Rising Three Times Faster Than In Previous 500 Years, Study Finds Science Daily

US swine flu vaccine too late to beat autumn wave New Scientist (Let’s hope worst fears are not realized)

What Does a Smart Brain Look Like?: Inner Views Show How We Think Scientific American (Very cool science)

When Ants Attack: Chemicals That Trigger Aggression In Argentine Ants Synthesized Science Daily

By Edward Harrison of Credit Writedowns

This comes via the FT:

Saudi Arabia on Wednesday decided to drop the widely used West Texas Intermediate oil contract as the benchmark for pricing its oil, dealing a serious blow to the New York Mercantile Exchange.

The decision by the world’s biggest oil exporter could encourage other producers to abandon the benchmark and threatens the dominance of the world’s most heavily traded oil futures contract. It is the main contract traded on Nymex.

Before anyone tries to spin this as an anti-dollar move, you should read what else the FT article says:

In January, WTI, which usually trades at a premium of $1-$2 a barrel to Brent, fell sharply, leaving it at a discount of almost $12 – a record gap. This dislocation in the market continued well into the summer.

From January, Saudi Arabia will base the price of oil for its US customers on a new index developed by Argus, the London-based oil pricing company.

The Argus Sour Crude Index will track the price in the physical market of a basket of US Gulf Coast crudes, including Mars, Poseidon and Southern Green Canyon.

The point of this move is not to undermine the dollar but to get away from the WTI contract where prices have been artificially inflated due to storage shortages at Cushing.

A friend familiar with this market also indicated that big bank punters active in this market will like this move as well as it helps them evade the position limits and regulation of the CFTC. He says, “In fact, the lack of transparency and regulation on the Dubai Merc was one of the reasons why you had such successful speculation in the oil market during the spring of 2008.”

I see a spike in oil prices as a risk to any sustained recovery. Anyone with more insight into why the Saudis made this move, do comment.

By Edward Harrison of Credit Writedowns

Yves is going to be in a light posting mode, so I will be posting some links and a few posts for your reading pleasure. The first one is an update to some thoughts that Yves had on GMAC on the 27th.

By the way, where is Jesse? I want to see him posting here too. (hint, hint)

And you thought the bailouts were over and market discipline might be restored.  Not a chance – the bailouts will continue, come hell or high water. The latest demonstration of this is GMAC, where the government will now be majority owner. GMAC has officially been nationalized. Now the government is running auto financing in addition to running the companies making the cars.

Below is a quote from the Financial Times. Notice the parts I have bolded.

GMAC, the car financing company, is set to receive up to $5.6bn in a new capital injection from the Treasury, filling a hole identified in the “stress tests” earlier this year and paving the way for the government to become the majority shareholder.

The company, formerly the financing arm of General Motors, was one of 19 institutions to submit to a capital adequacy programme led by the Federal Reserve and completed in May. That determined that GMAC had a shortfall, which will now be provided by the government in the form of preferred equity, according to two people familiar with the situation.

As widely expected, GMAC has been unable to raise the necessary capital in the market and the company – which will take on fresh lending responsibilities when it merges with Chrysler Financial – was seen as vital to the government-led restructuring of the US automotive industry and deserving of more funds from the $700bn troubled asset relief programme.

“When we laid out the stress tests, we expressly said that some additional Tarp capital may be needed given the severity of the downturn – this capital need is not new information,” said an administration official.

“But the transparency brought about by the stress tests allowed all other institutions to raise the capital required by the stress tests to ensure these firms could withstand a more severe economic scenario than anticipated,” the official said.

What you should be reading from this statement is the following:

• All the firms identified as lacking capital under the stress tests were given time to raise funds in the capital market to meet the shortfall.
• Some firms did meet the shortfall and they are now free to do as they please.
• Others have not and we the government are now going to take a more muscular approach in dealing with them.
• GMAC is the first public example of our flexing our muscles.
• But there surely are/will be other examples; some may already be happening in secret.

If the US government is going to throw its weight around to deal with financial firms short of capital, I would personally prefer they try a process which allows these firms to fail whereby equity and debt holders suffer consequences that are consistent with taking market risk.  Bailing out GMAC is a moral hazard plain and simple.

But, what’s done is done. The GMAC case does, however, give a lot more credence to my view that Citigroup’s actions are being dictated by government. As I indicated when the stress tests were done in April, firms were going to get some time to raise capital and if they didn’t, the government was going to move on to Plan B (debt-for-equity swaps, nationalization, and FDIC seizure). Expect to see more indications that other financial companies with capital shortfalls are falling under the government umbrella.

Your humble blogger is WAAAY behind the eight ball! Apologies! Some of you sent very nice links and some good research too, and I am sorry I am not able to take advantage of them.

I am very much under the gun till next Wed, I am afraid my posts will be thin. Please bear with me, thanks!

By George Washington of Washington’s Blog.

On September 25th, I wrote:

Paul Volcker and senior Harvard economist Jeffrey Miron both testified to Congress this week that the government is trying to make bailouts for the giant banks permanent.

Writing Wednesday in The Hill, Congressman Brad Sherman pointed out that :

In my opinion, Geithner’s proposal is “TARP on steroids.” Section 1204 of the proposal [the proposal being the "Resolution Authority for Large, Interconnected Financial Companies Act of 2009"] allows the executive branch to use taxpayer money to make loans to, or invest in, the largest financial institutions to avoid a systemic risk to the economy.

Geithner’s proposal reminds me of the Troubled Asset Relief Program (TARP), the $700 billion Wall Street bailout adopted last year, but the TARP was limited to two years, and to a maximum of $700 billion. Section 1204 is unlimited in dollar amount and is a permanent grant of power to the executive branch. TARP contained some limits on executive compensation and an array of special oversight authorities. Section 1204 contains absolutely no limits on executive compensation and no special oversight.
When I asked Geithner whether he would accept a $1 trillion limit on the new bailout authority (if the executive branch wanted to spend more, it would have to come back to Congress), he rejected a $1 trillion limit, insisting that the executive branch be able to respond without coming back to Congress.

Both TARP and the Treasury proposal have vague provisions under which taxpayers might possibly recover any money lost through a special tax on the financial services industry. Under the Treasury proposal, only the very largest institutions could benefit from a bailout, but the special tax, if ever collected, would fall chiefly on medium-sized institutions.

Thus, the medium-sized institutions will be at a competitive disadvantage for two reasons. First, the largest institutions will be able to borrow money more cheaply because their creditors will believe that if the institution is unable to pay, the taxpayers will. Second, if there ever is a bailout benefitting a very large financial institution, the tax will be imposed on the medium-sized institutions.

Sherman is a senior member of the House Financial Services Committee and a certified public accountant, so he has a good nose for analyzing proposed financial regulations.

Last week, Sherman made the following comments to the Washington Independent regarding Congress’ proposed bill on the too big to fails:

That is a huge gravy train to the top 20 [financial institutions] because it allows them to borrow money at a lower rate. Think of what this does to moral hazard.

I’m not looking for a TARP on steroids with oversight. I’m looking for an end of TARP.

The House Committee on Financial Services will hold a hearing on the bill tomorrow, with Tim Geithner, Sheila Bair, John C. Dugan (Comptroller of the Currency), Daniel K. Tarullo (Governor, Board of Governors of the Federal Reserve System), John E. Bowman (Acting Director, Office of Thrift Supervision), Richard Trumka (President, AFLCIO), and others as witnesses.

As the Washington Independent points out, Sherman is going to try to take Tarp off of steroids:

Sherman said he intends to offer a series of amendments addressing the issue during the Financial Services panel’s markup of the bill, which has yet to be scheduled. Included will be a provision to cap the president’s bailout authority at $1 trillion, and another to strip out the resolution authority language entirely. A potential third proposal — to create an oversight panel like that monitoring TARP funds — is one he’s leaning against.

By Edward Harrison of Credit Writedowns.

DoctoRx, Rob Parenteau and Marshall Auerback have each written articles here to bring clarity to some issues I first raised at the beginning of the month in my post, “The recession is over but the depression has just begun.”

As I see it, the issue we are debating has to do with how the government responds when large debts in the private sector constrain demand for credit in the face of a severe economic shock and fall in aggregate demand. In short, if private sector debt levels are so high that a recession precipitates private sector credit revulsion, how should government respond?

Frankly, this question is as much philosophical and political as it is economic.  So I want to wait to answer it and first frame the monetary system in a way which reveals the political nature of the question. Afterwards, I hope it is apparent that there is no one answer to this question and that any society’s answer depends on and reveals its priorities as a people. I will try to make some concluding marks about government debts and taxes in a fiat currency system given the analysis Marshall’s post.

Money and the sectors of the economy

Money is a tool, a medium of exchange, which derives its value from its utility in allowing individuals in an economy to trade goods and services. It eliminates the need to barter and make direct exchanges of goods and services in order to trade. Think of any economy as a collection of individuals or groups which trade goods and services with each other and with the outside world in exchange for a money-value of those goods and services. Each transaction is an exchange of a good or service for a equivalent value amount of money.

So, in any country, the flow of goods and services should be a one for one mirror image of the money flows. Now, if you break an economy down into sectors like the government sector, the private sector, and the foreign sector, the same is also true. Two accounting identities flow from this.

• In any particular time period, the changes in both money value of goods and the changes in the financial balances must sum to zero.  As Rob, illustrated: Household FB + Business FB + Government FB + Foreign FB = 0
• One sector’s deficit is another sector’s surplus. Think of it this way, if you and I are the only ones in the economy. If I spend more than I earn in, say, one particular month to buy your goods and services, you must have spent less than you earned in that same month to buy my goods and services.

If you take Rob’s formula and combine the two sectors of households and businesses into one sector, the private sector, you are left with Private FB + Government FB + Foreign FB = 0. What this means is that in any given time period, the private sector financial balance is offset by the government and foreign sectors’ balance such that they all sum to zero.

Private sector debts and credit revulsion

Given the framework above, it should be clear that when the private sector has a net surplus, the government and foreign sectors must have a combined net deficit.

So what happens when the economy lapses into recession because of a financial crisis caused in large part by excessive leverage and debt?

The answer is credit revulsion, also known as deleveraging. And this is what we have just seen in the U.S. economy.  Credit revulsion means that the private sector (businesses and households) reduce or are forced to reduce their debt burdens. This change in behavior induces a net surplus in the private sector; the private sector increases savings.

I’m sure you know where this is going. If the private sector moves to a net surplus, the combined government/foreign sectors must axiomatically move to a deficit.

A foreign sector deficit means that we are net exporting i.e. foreigners are buying more stuff from us than we are from them. We are talking money flows here not goods and service: more money coming in than going out (FB deficit) means fewer goods coming in than going out (current account surplus). Since the U.S. is not going to run a current account surplus, I am going to leave this out of the discussion to focus on the real issue: Government.

We can try and reduce private sector savings

So, the result for the U.S. of a private sector which is net saving is government deficits – this what naturally flows from a credit-revulsion induced private sector deleveraging. By saying this, I am stating fact, I am not making a political argument for or against deficit spending.

However, this is where the political/philosophical discussion starts. Two questions come to mind.

• Do we want the private sector to net save at this point in time?
• If so, do we want this savings to occur in an environment of more aggregate demand or less?

Policymakers today have answered no to the first question. They have said, “we do not like credit revulsion and our preferred policy choice is to work against it by reducing private-sector savings.” How do they do this? They lower interest rates in such a way that there is less incentive to save. Policymakers are in effect voting to continue the asset-based economic model.

But, there are several problems with this policy decision: it rewards debtors over savers, it prevents deleveraging from occurring, it creates asset bubbles, it keeps zombie companies and overcapacity alive, and it misallocates resources by artificially lengthening time preferences for money. In short, it is poor policy and it will end poorly as well.

Or we can maintain it and decide to either increase or decrease aggregate demand?

If you reject this policy path, you then have two options. In one, aggregate demand is reduced. In the other aggregate demand is increased.  Which option we choose, again, depends on politics.

In a July post, I outlined the choices. (Note the labels ‘surplus’ and ‘deficit’ should really be labeled ‘financial balance.’ For simplification the foreign sector isn’t depicted but one could assume it is aggregated with the government sector.):

In the Minsky world, the increase in net savings in the private sector and reduction of the current account deficit is axiomatic when the government is increasing deficits.  The point is that the private sector net saving and current account deficit must equal the government deficit.  So, when the combined private savings and current account deficit increases, the government’s financial balance must become more negative.

What this implies is this (diagram from Paul Krugman’s post with the unfortunate title “Deficits saved the world”):

To make the graph easier to follow we start with sector balances at zero i.e. where sector surplus/deficit equals zero for both the private sector including the current account deficit and for the government sector. And just to be clear, points above the line show private sector savings or public sector deficit.

1. We start where the red circle is.
2. When an economic shock hits which precipitates a massive deleveraging, the entire demand curve shifts to the left to a new lower GDP level, everything else being equal. Thus, deleveraging equals recession. And we now see the private sector curve hitting the public sector curve where the blue circle is. The private sector is now saving and the public sector is in deficit. That is where we are today.
3. However, to bring things back to neutral i.e. where sector surplus/deficit equals zero for both sectors, one could cut government spending dramatically.  That shifts the entire government curve to the red line on the left, leaving us where the green circle is: in a deep, deep depression. Krugman calls this the Great Depression outcome.

The cult of zero imbalances

In the depression post which kicked off this debate, I said “I must admit to having a preternatural disaffection for large deficits and big government which is what Koo and Minsky advise respectively.” Consider me a card-carrying member of the cult of zero imbalances. My preference is to see a neutral state where the sectors are balanced as the average long-term outcome. We may deviate from a zero imbalance state over the short-term, but we should be working toward it over the longer-term.

However, in the interim, what we want is to get back to that red circle in the chart and higher GDP and stay away from the green circle and lower GDP – also known as depression.  The difference between these two is government deficit spending.

Depressions are downward economic spirals. And when I invoke the term spiral, you should not be thinking of some stable equilibrium like the Great Moderation, Goldilocks economy, Nash equilibrium or some other close facsimile of economic Nirvana. You should be thinking war, famine and pestilence because those are the events which are historically associated with periods of high deflation and depression.

For me, the choice is clear.

The key is liquidation of overcapacity

While the picture I presented above represents a single point in time, what we want to know is how we get back to the green circle over time. In the depressionary example, we contract immediately and violently as aggregate demand is reduced in both the public and private sectors. The result is a liquidation of overcapacity and a depression. In the pro-growth example, aggregate demand is boosted by government spending whilst the private sector deleverages. In this scenario, liquidation of overcapacity also occurs if the government allows it to do so.

And this is the key: to the degree that government deficit spending is used as a vehicle for channeling funds to so-called systemically important businesses to prevent them from failing, we are merely kicking the can down the road. With the deleveraging, malinvestment must be purged for the economy to right itself on a sustainable growth path.

Government’s hidden debt?

That brings me to the last point: government debt. The first issue I want to address is unfunded liabilities.  This is something of great concern to many (including myself).  However, when we are talking about debt and credit, it is not particularly relevant. I mention this because of my statement in the original post:

The government plays a crucial role here because of the huge private sector indebtedness.  In the U.S. and the U.K., the public sector is not nearly as indebted.

A lot of people want to bolt the unfunded liabilities onto government debt to make the government’s debts appear larger than they actually are.  But when talking about the credit system, we have to be careful and distinguish between obligations and actual debt – related but different terms.

In a period of credit revulsion, the key issue is the overall credit in the system. At issue is a debtor’s inability to meet large existing obligations such that the debtor defaults, the obligation is written down, and the overall credit in the system contracts by the amount of capital that has been allocated to that writedown. The issue is credit writedowns and how they suck capital out of the system, reducing credit and leading to a potential deflationary spiral. It has absolutely nothing to do with unfunded obligations.

The governments unfunded liabilities for social security and healthcare are akin to General Motors’ unfunded pension liabilities. GM’s unfunded liabilities are germane to a credit crisis only to the degree they flow through the income statement and, thus, require credit financing in real time.

Government and its money

The difference between GM and the federal government is vast, however. General Motors is a private organization which must fund its obligations by selling products.  To quote Ben Bernanke’s now infamous words:

the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.

The U.S. government has monopoly control of the currency and no other entity can print money as a medium of exchange in the United States (see my post “The origin of the U.S. dollar as legal tender and its link to Depression” for how this came to be.)  When anyone else attempts to print money, it is called counterfeiting. In saying this, I am stating fact, I am not making a political argument for or against legal tender laws.

This is a problem for states – which cannot print their own money – and for Eurozone countries – which also cannot print their own money (as I laid out in my post, “Depressionary bust in Ireland is echoed in California”) – but it is not a problem for the U.S. government. If the U.S. government so chooses, it can ‘fund’ any purchase with additional money it prints. It is not constrained in the same way private sector actors or even states and local municipalities are.

It is disingenuous for economic pundits like Marc Faber to suggest the U.S. is going to go bust. The United States will not literally be declared insolvent as long as it issues debt in its own currency. Countries that have gone bust, Russia, Mexico, and Argentina were borrowing in foreign currency because of interest rate differentials. No sovereign nation which prints and issues debt in its own fiat currency can ever involuntarily be made insolvent.

Inflation is another issue altogether.  When the economy is operating at potential, money printing leads to consumer price inflation. But this is not the case right now, there is an enormous output gap that is not going to be closed anytime soon.  So the government can print all the money it wants and buy all the Treasuries it wants; none of this will lead to consumer price inflation in the short run except via dollar depreciation and import prices. Again, I have to remind you that in saying this, I am stating fact, I am not making a political argument for or against quantitative easing.

I should point out that the output gap is why money printing is leading to an asset price bubble both in the U.S. and globally and one reason we should reject QE even in the absence of consumer price inflation (this line was added because the initial comments suggested readers thought I am advocating quantitative easing when I am not).

I hope this post adds to the debate Marshall, Rob, and DoctoRx have taken on.

Australia coastal living at risk BBC (hat tip reader John D)

Antipsychotic Drugs in Kids Linked to Weight Gain Bloomberg These comments from DoctoRx:

These drugs are wildly overprescribed because Obama’s new friends push and then push some more to get MDs to prescribe probably the single most overpriced class of drugs on the entire planet to helpless kids. The overuse of psychiatric drugs is a huge scandal-bad for national health and wealth.

In addition, the use of antipsychotics in the demented elderly has been proven wildly unsafe, but they continue to be widely prescribed. Guess why?

5 years ago a single Zyprexa tab- which costs 2-3 cents per pill to make at the most- went for $7. I know for certain that these drugs have over a 99% gross margin. Why? Because we have a lunatic system that let’s them get it! And then they know how to get them overprescribed on top of the overcharging.

40 States Ask FTC To Crack Down On Debt Relief Companies Consumerist

Why rich college kids can sell dope and you can’t Denver Westword (hat tip reader John D)

Former Chair of Citigroup: Restore Glass-Steagall Barry Ritholtz (hat tip reader Scott)

Got Perfect Credit? You Could Be Charged For It! HDTV (hat tip reader Alex G). This may annoy some readers, but the only way to have credit cards not be a product that has to feast of the chronically indebted is to have everyone pay an annual fee. That was the model until the late 1980s, and interest rates and fees were not rapacious.

Wall Street adds insult to injury Dean Bake. Guardian (hat tip DoctoRx)

Goldman Lobbies Senate, Says Full Transparency Sucks Matt Taibbi. God, I’d love to be on the distribution list for these Goldman lobbying documents. They are brazen. Goldman must be so confident of getting what it wants that is no longer concerned whether its arguments make sense or not.

Never Send a Boy to Do a Man’s Job Epicurean Dealmaker. A nicely done rant.

Antidote du jour:

By Marshall Auerback, an investment strategist and analyst who writes for New Deal 2.0.

A major shortcoming in an otherwise thoughtful post by DoctoRX on deficit spending is a traditional mistake in which analysts seek to analogise the expenditures of government with that of a private household or business. The government is sovereign. This fact gives to government authority that households and firms do not have. In particular, government has the power to tax and to issue money. The power to tax means that government does not need to sell products, and the power to issue currency means that it can make purchases by emitting IOUs. No private firm can require that markets buy its products or its debt. Indeed taxation creates a demand for public spending, in order to make available the currency required to pay the taxes. No private firm can generate demand for its output in this way. Neither of these statements is controversial; both are matters of fact. Nor should they be construed to imply that government should raise taxes or spend without limit. However, they do imply that federal budgeting is different from private budgeting, and should be considered in its proper, public context.

It simply means that the government does not “need” money to “fund” its operations. It seems counter-intuitive, but the public actually needs the government’s money to pay its taxes rather than the government needing taxes to pay for highways, bridge repairs, schools, national defense, etc. For the household, paying back debt means they have to sacrifice current consumption (spending). For the government, no such financial constraint is imposed. Its ability to spend now is independent of how much debt it holds and what is spending was yesterday. That situation can never apply to a household or business firm.

Because the government is the only entity that gets to create money, it can “buy” whatever is for sale in terms of its money merely by providing that money to the public, which opens up a huge range of policy options. Putting this in concrete terms, the government–‘buys’ a new highway or a new aircraft carrier, as long as the construction materials and workers’ wages can be paid for in its own currency.

Where does the government get the money? The government creates this money by crediting bank accounts. It creates money with the stroke of a computer keyboard. New money is an entry on a spreadsheet, nothing more.

To put this in everyday terms, the dollars the government creates function something like tickets to the Super Bowl. As you go into the stadium, you hand the man a ticket worth $1000, and then he tears it up and throws it away. Why? Because the ticket has served its function: it has enabled you to gain entry to the event in question; similarly, a tax is paid to extinguish a state liability, but as soon as the tax is paid, it has no further value to the government. The tax receipt can be sent to the shredder. Tax payments (which discharge a liability to the state) then “drain” the money we call legal tender (otherwise known as “fiat currency”), which can be pictured as a movement of funds away from the private sector and “down the drain” as the money is literally burned, or simply wiped off the liability side of the Federal Reserve’s balance sheet.

How does the government taking your tax money and throwing it in a shredder pay for anything? The answer is that it doesn’t.

Taxes function to reduce aggregate demand, also known as spending power, and not to collect what the government needs to spend on something else.

As a matter of conceptual clarity, it makes no sense to say that a government ever “builds up a store of savings” that allows for higher spending capacity in the future. The government neither has or doesn’t have any dollars; it simply makes computer entries on a bank’s balance sheet, as Federal Reserve Chairman Bernanke described in the “60 Minutes” interview above.

It spends by changing numbers upwards in our bank accounts. Think of this like a football game. Awarding 6 points for a touchdown doesn’t “use up” some stock of points held by the stadium. It is “electronically credited” via the scoreboard. Nobody asks that the 6 points be “repaid” somehow.

You don’t “save” what you have the option of creating or not creating (i.e. fiat currency). Not spending, not “creating currency” via crediting bank accounts, simply means less present day economic output.

We all learned this as the paradox of thrift.

There is nothing to “save”. The government is never revenue constrained.

This is in contradistinction to the way users of the currency, versus the issuer of a currency, such as a household functions.

For them, spending is constrained by income. Their checks will bounce if there is no money in their accounts. And for users of the currency monetary savings can be stored to permit higher consumption in the future. And households don’t have an electronic printing press in their basements which would eliminate that constraint. As Rob Parenteau has already noted, this is called “counterfeiting” and it’s a jailable offence.

True, if a government spends too much after getting us to a state of full employment and higher economic growth, excessive government spending can create inflationary pressures. So to that extent, there is a limit. But acknowledging that unconstrained government spending can create inflation is not the same as arguing that it is in any way operationally constrained. Contrary to conventional “gold standard” thinking, where it is said that every DOLLAR SPENT HAS TO BE ‘FINANCED’ BY AN OUNCE OF GOLD ALREADY IN EXISTENCE, our government can afford anything that it is for sale in its own currency.

The debate therefore should not be focussed on “affordability” but on what our the national priorities of our government? The political process, not a non-existent gold standard, determines that if we want more killing toys then the national government can always meet those expectations in a fiscal sense, unless we run out of real resources. Likewise if we desire universal health care, in a manner where the government provides this as a national right, rather than foisting it on business as a marginal cost of production (remember, businesses are constrained in a way that governments are not).
Further, if there is a problem with excessive private indebtedness and overspending, then the mirror image of that has been the excessive fiscal drag that the national government inflicted on the USA between 1996 and 2007. If you want the economy to grow and produce the saving capacity (via income growth) to allow the private sector to repair their precarious balance sheets then the last thing you would want to do is run “tight Budgets … for a long time into the future”.

What is needed when the economy has been driven by private spending funded by ever-increasing levels of debt (and a contracting public sector as a proportion of total output) then what is required is a change in the composition of final expenditure – from private to public – unless you want to “scorch the earth” and deliberately contract the economy.

The consequences of overspending might be inflation or a falling currency, but never bounced checks a government creating its own currency can never go broke. Government spending limits ought to be set by our policy makers by considering what we, as a society, want, like universal healthcare, full employment, a well-functioning economy and our ability to accomplish this—not out of some preconceived notion of what is “affordable”.