I predict that, looking back, today will mark a low point for the Obama presidency. From Adam Serwer at Xpostfactoid:
"Good God, is this the day the Obama presidency died? Horrendous monthly jobs numbers make it seem so. As the economy dives toward double-dip recession, the president is a self-bound hostage to the GOP, mired in calamitous-looking deficit reduction talks, the results of which are likely to further crimp growth while shredding the safety net. Having let the GOP set the agenda, Obama is unlikely to find a way to further stimulus.
"This feels like nemesis nipping at the U.S.'s heels, the next tumble down a staircase that began with the Lewinsky scandal, carried through the busted and stolen 2000 election, then on to Bush busting the budget and defunding the federal government while shredding civil liberties and various norms and taboos of governance. Now, I'm haunted by Cassandra Krugman's constant forecasts of calamity triggered by too-weak progressive response to the financial meltdown, half measures that discredit a sane stimulative response. Now the lunatics are poised to once again take over the asylum after four years of powerful incentives to sink ever deeper into lunacy -- discrediting stimulus, discrediting the once-conservative approach to universal healthcare codified in the ACA, discrediting effective regulation, discrediting an even minimal safety net."
Where does this come from? It comes out of fear that the economy is not on the rebound, that this move towards austerity is the wrong direction, that Obama has bought the austerity kool-aid, that big spending cuts will send us down the economic chute, and that we will never do the investment spending needed to get the economy moving. In short, if Obama buys the Republican line that it is government deficit spending that has put us in this hole, then Democrats are in trouble, and so is the country.
Here's my hope: Obama has not fully bought the austerity story. He wants to get our long term budget house in order, and, at the same time, recognizes the need for short term investment spending. He is betting that by putting together a "big budget deal", with most of the cuts in out years, he will be able to quiet the opposition, steal Republican thunder, and put himself in a strong position for 2012.
He also thinks there is a very good chance Boehner will not be able to deliver the votes. He may in fact be betting that this is the most likely outcome. If the vote fails and the debt ceiling is not raised, Obama will tell Geithner and the Fed to keep paying the bills, without raising the debt ceiling - in other words, just "keystroke" some new money to pay creditors, but don't issue new bonds. Obama will go on TV and tell the American people: "I did my best to get a bipartisan budget deal. At the leadership level, we reached agreement, but Republicans couldn't deliver the votes. To prevent default, and still not violate the debt ceiling statutory limit, have instructed Treasury to pay the bills, but not to issue any new debt."
Our understanding of macroeconomics is so extraordinarily weak that we do not understand that the Government does not need to issue bonds to fund our deficit. The US has its own currency. It can create new currency any time it wants, as Bernanke has said, "by keystroke." If you look at the detailed Fed records during the crisis, you will see that they did a huge amount of new money creation, in order to buy up lousy mortgage assets from the banks and to fund international swap lines, when Europeans ran tight.
Republicans, if they don't provide the votes for a debt ceiling deal, particularly when the President has bent over backwards to put together a "big deal", will be in trouble. They will be solely responsible for pushing the US over the cliff. How mad will they be when Treasury keeps paying the bills. Furious. Apoplectic. Yet what will the President have done wrong, if he doesn't issue any new debt? We heard today from the General Counsel at Treasury that the 14th Amendment defense will not be used to issue new bonds. So if no new bonds are issued, and the bills keep being paid, and the President is faithfully honoring the 14th Amendment, is it his fault if no one in Washington understands money economics?
He will be accused of bad faith negotiating, and he will say, correctly, that he really did want the budget deal, and that he never said he would not order Treasury to keep paying the bills. Republicans will look like utter fools.
I think this is Obama's game. It's why I am not as discouraged as Adam.
Hi Jim. I'm intrigued by your analysis.
ReplyDeleteYou write that because we don't understand macroeconomics well, we don't realize that the government doesn't need to issue bonds to fund its deficit. The US "can create new currency any time it wants, as Bernanke has said, 'by keystroke.'"
Perhaps I've misunderstood you, but I gather from that worry-free paragraph that this is something you'd suggest.
Just curious: Are you familiar with the experiences of the Weimar Republic re the effects of simply printing money "by keystroke"?
You continue: "If you look at the detailed Fed records during the crisis you'll see they did a huge amount of new money creation, in order to buy up lousy mortgage assets from the banks and to fund international swap lines, when Europeans ran tight."
Again, possibly I'm not reading you right: Are you literally saying the *Fed* bought "mortgage assets" from the banks, or simply that the Fed printed money to *loan* to banks?
Thanks for clearing up your position on these questions.
Hi SF,
ReplyDeleteThanks for your note and questions.
First, about the Fed creating new money by "keystroke", and am I cavalier about that, remembering the Weimar story.
Most of us simply do not understand how our money system works: for example, we do not need debt issuance to fund our government spending. In a fiat currency country, money is created by the central bank by "keystroke".
It's not a question of whether I am casual about this: it's important to understand that this is how the money flow system really works.
Weimar was a hyperinflation situation where a complex chain of Post World War I events happened that caused German production capacity to shut down while the Government kept printing money to pay war reparations. So scads of money chasing little or no resources led to hyperinflation.
Could that ever happen in the US? Yes, but only if we got into a resource constrained, overheated economy much worse than the last time we had a serious inflation bout - in the 70s'. Right now we have huge excess capacity in our economy - high unemployment, low market demand - and the inflation risks are low, as our low interest rates and low Treasury markets show us.
During the crisis, the Fed expanded its balance sheet almost five times, ending up just under $3 trillion.
The Fed bought $1.25 trillion of MBS (mortgage backed securities), essentially all government-backed securities, with the purpose of aiding the housing market and keeping mortgage rates low. They also financed/owned three partnerships (Maiden Lane I, II and III) to buy up toxic assets from Bear Stearns and AIG. This is where a bunch of real crap went, including a lot of trash CDOs'. So far, the Fed is keeping its head above water on these assets, holding them and managing the portfolio down slowly. Not sure the total involved here - probably $100-$150 billion.
TALF (Term Asset-Backed Loan Facility) was another $200 billion, designed to loan money to wealthy investors for them to buy up consumer asset-backed loans (cars, credit card, student loans, etc). This has worked out well for the Fed and for most investors. This program is planned to wind down by 2015.
Another critical part of the Fed's activity during the crisis was the Primary Dealer Loan Facility, essentially the Fed's Discount Window for banks. The non-regulated/shadow banking sector was allowed to borrow here, where normally only regulated banks could. The Fed also expanded the types of collateral they would accept for these loans, presumably to include some MBS. What was discovered when the Fed finally had to publish who they loaned money to was that a host of foreign banks and other institutions also used this facility, which surprised and angered a lot of folks. This program ran for about two years.
Finally, the program we all know about - QEII, where the Fed, over time, purchased $600 billion of Treasuries to try to further flatten the yield curve on Treasuries and stimulate economic activity, with obviously mixed results.
Republicans rail against the $800 billion stimulus. What the Fed did in money creation and financial asset purchases was three times the stimulus amount. A HUGE increase in money, potentially Weimar-like, and not a quiver in the core inflation rate or the 10 year Treasury market.
Yes, the Fed bought financial assets. Yes, hyperinflation is possible, but it depends on the underlying economic position of the country - what is the state of resource utilization. If we pump money in, does the economic system have the capacity to respond without bottlenecks? And when you are in a classic "liquidity trap", do individuals even want to spend money, or do they use it to improve their balance sheets?
And thanks again for your questions.