Re: Neglected prophets!

[paul davidson <pdavidson@xxxxxxx>]

At 09:02 PM 02/21/2000 -0500, Warren wrote:
> And, with all due respect, I still don't see it that way.



And of course Warren is raising a very appropriate question -- namely

(1)if the government insists on attempting to maintain a surplus -- and
therefore attempting, ceteris paribus, to produce a deflationary
(oversaving) force --- , then who -- or what sector - will be spending more
than they are earning in order to maintain the high level of effective
demand that the US has enjoyed in the last 2-3 years?  This is of course
exactly the point -- and is part of the argument that Jamie Galbraith and I
were making in our WSJ editorial page article.  The resulting disruption of
the Treasury security -- long term debt  capital market was just one
manifestation  -- and not necessarily the most important aspect of our
macroeconomic problem.

> First, note that total govt securities held by the non
> govt sector, for all practical purposes, merely offset
> clearing system 'operating factors.'

I am not clear as to what you mean in this turgid sentence Warren.

> Second, when the govt runs a surplus, the 'short cut'
> answer is that at the end of the day govt securities
> were 'used' by the non govt sector to pay taxes.

In essence the public was paying more in taxes than the government was
spending ON A CASH FLOW BASIS (since almost the entire "surplus" is due to
social security revenues vs. benefits.)

>   So,
> technically, there are no excess clearing balances
> (reserves) available to buy govt secs (otherwise the
> Fed would immediately offer govt secs for sale, of course).

To the extent taxes are paid by drawing checks against the banking system,
then the banking system is losing reserves to a the combined balance sheet
of the central bank and the central government.

> The primary function of govt debt (with a floating
> exchange rate) is 'interest rate support.'  Long term
> govt debt serves to support long term interest rates.


Support? Stabilize? What assumption regarding the liquidity preference of
the public?

> What we are seeing is long rates falling as this 'support'
> dwindles.


As supply available to the public vis-a -vis demand for holding long-term
debt by the public (including foreign central banks, pension funds, etc.)


> So perhaps the question is, would a corporation, for
> example, rather have a more liquid long term market
> (narrower bid/offer spreads, etc) or lower long term
> rates when it sells its bonds?

Is this corporation a borrower or a lender? And is the lender corporation
holding the bond (even though it is a long term instrument) for the
short-term??




> And Paul's point, becomes a 'sector' question.  There are
> many investors, for example, with long term liabilities that
> desire long term securities.  Fewer long term govt securities means those
> investors will either have to take more default risk and buy non govt
> long term debt, or buy shorter maturities, and take interest rate
> risk.


What about foreign central banks who hold Treasuries as foreign
reserves.  Aparently about 20-30 of the outstanding debt is held by
foreigners including the central banks (even the Eurobank and the Bank of
Japan)?

> If we feel it serves some public purpose to provide private pension
> funds with govt guaranteed annuities, fine.  It's kind of the reverse
> of privatizing soc. sec?


An excellent point.

>  Are the same people pushing for other
> secs for the soc sec fund now pushing for more govt secs for the
> private funds?

No I believe there is a need for an anchor upon which various "risker"
private debt obligations can be compared vis-a-vis a "riskless" debt
obligation -- riskless in the sense that there is no chance of default in
terms of the US dollar -- as long as the global economy is basically on a
US dollar standard.

> Third, with our (nominally) growing economy
> and our current tax structure that results in the
> govt surplus, as a practical matter it is but
> a point of logic that non government debt is growing.
> (And we all know that this is not sustainable, as
> Wynne Godley points out www.levy.org.)


Depends on what you mean by sustainable?  As a mathematical exercise of
course as one approaches infinite the private debt can become infinitely
large.

Whether a private or a public debt is sustainable into the "reasonable
future" is a question of cash flow inflows and debt servicing obligations
--- and thus inevitability is not a word I would use.  The problem is does
the cash flow commitments set off a liquidity crises -- and even if it has
that potential for a liquidity crises exist does not an "intelligent"
policy maker the wherewithal to offset the liquidity shortage. Liquidity in
some sense involves double booking -- as Warren's chartalist concept
implies-- and hence is controllable if one understands the problem.

> So we know
> some entity is holding/buying the debt or the economy
> would not be growing.


Indeed growing indebtedness can be a mark of a successful agent or a
successful economy-- as long as an unexpected liquidity crises does
not  occur.  If you can go into you banker tomorrow and borrow a million
dollars, you are clearly more successful than I am -- for my line of credit
with my banker is only a few paltry thousand.

>  My point here is yes, there is
> greater risk associated with increased holdings of
> non government paper due to the surplus, but the risk
> comes from the fiscal policy of running a surplus itself
> and not the lack of govt secs.


Jamie and I agree that it is the surplus that is the fundamental problem
--as our WSJ made clear. Our point here was that one manifestation of this
basic problem would be the greater volatility of  capital markets --
especially given the Greenspan view that surpluses are good and should be
maintained (as compared to increasing government services on goods and services

>   The systemic risk grows
> as the surplus continues.  And this will necessarily correlate
> with declining govt secs and increased holdings of
> non govt debt.
>
> Currently it is this declining net desire to save of the
> non govt sector, as evidenced by the combination of
> increasing private sector debt and the govt surplus,
> that sustains the expansion.  And when the net desire
> to save 'hits bottom' nominal growth will slow.


Absolutely correct.