Re: fiscal deficit - Mosler addendum

["Per Gunnar Berglund" <pgberglund@xxxxxxxxxxx>]

In response to Warren Mosler:

Warren wrote:
> What I said is that lack of a collateral requirement devalues that
currency.
> I'd be first in line, if I could run fast enough, to borrow all of that
stuff on
> those terms the Fed would lend me, and 'spend' it as fast as I got it.
>
> However, when I have to put up collateral for the same loan,
conservatively
> valued at the time, three things happen.  First, the amount I can borrow
is
> limited by the collateral I have available for pledging.  Second, I am
motivated
> to pay back the loan and get my collateral back as the loan value is less
than
> the collateral value.  Third, if I don't pay the loan back the Fed sells
the
> collateral which directly supports the value of the currently.

Per says:
All this is true, yet I am by no means convinced that a collateral
requirement per se is the springing point. After all there are other ways to
limit the amounts lent. What collateral requirements do, it seems to me, is
to add 'equity' to the system by making everybody in the possession of
collateral equal before the Fed, if you wish. In the absence of such rules,
the system might easily become unfair in that the allocation of credit might
become 'politicised'.

Another point: There seems to me to be no difference in principle between
Fed lending and other lending such as private bank loans. I think it was
Leigh Harkness who said that bank money retains its value because the loans
which created it must be repaid. The core point, I think, is not whether
loans are collateralised but whether they are limited.

Warren wrote:
> This is not to say that collateralized lending is sufficient to support a
> currency.
> It is to say that if the issuer lends unlimited and without collateral the
> currency
> will soon be worthless, but if it lends and demands collateral such
lending
> will not cause the currency to be worthless.

Per says:
As above.

Per wrote before:
> > There is clearly a two-way causation problem in this: on the one hand th
e
> > bills are 'backed' by the collateral; on the other, the prices of the
> > collateral assets are bid up and inflated ('asset-price inflation') when
> > bills are being over-issued.

Warren replied:
> All true.  Fed lending practices can support asset prices.  However, all
else
> equal, I would suggest that increases in asset prices in the above example
would be bubular (made up word for bubble effect) in nature.

Per says:
This is an interesting point. Your 'bubular nature' wording suggests that
you're thinking the asset values are ultimately anchored in 'fundamentals' -
meaning essentially profit flows - and then subject to speculative
expectations-driven deviations such as the recent bout of 'irrational
exuberance'.

Another way of looking at it would be to say that the general level of asset
prices is determined by the interaction between liquidity preference and the
stock of money. Suppose people want to hold a proportion, say x, of their
wealth W in liquid (money) form. If the money supply is M, then we should
have M = W.x.

This equation may be thought of as an identity (true by definition), much
like the 'Equation of Exchange' MV = PY, upon which one can impose various
behavioural functions and also, importantly, two directions of causality: In
the EoE, one can think of MV as the determinants of PY ('monetarism'), or of
PY as the determinants of MV. The same applies to the equation I just cooked
up: one can look at M as the factor behind W.x or as W.x as the factor
behind M.

The important point is that if one says that the causality goes from W.x to
M, which I take it you do, then one must come up with a coherent story about
the determinants of W and x in order to have oneself a theory. If one takes
the equation the other way round, one will need a story underpinning M and x
in order to have a theory of asset prices W. My way of thinking about this
is to look at M as short-term fixed by the banking system ('exogenous
money') and to look at liquidity preference along Keynesian lines. On this
view, W will be the short-term endogenous factor.

This does not rule out the idea that W feeds back into M through its role as
collateral for bank loans, but I personally think of that as a dynamic
relationship involving some adjustment lags.

Per wrote before:
> > So the question is if it is the value of the
> > currency which is anchored in the collateral, or if it is the other way
> > round?

Warren wrote:
> 'Value' is ultimately determined in the 'vertical' component.  But that is
not
> to say it can't 'flap in the breeze' of the horizontal component.
>
> For example:
>
> Suppose NYC subway tokens cost $1.50.  The value stays at $1.50 unless the
> city changes the price (or the fare (tax) collection ceases).  But what is
the
> 'market' value?  Well, if you tried to buy a few off your neighbor you
might pay
>
> a bit more, and if you tried to sell a few you might get a bit less.  But
> nevertheless,
> it is 'not wrong' to say NYC is price setter and the price is $1.50.
>
> Now lets toss in a major disruption.  Suppose you had your house for sale
at
> $125,000 and someone initially offered you 87,500 subway tokens for it,
and you
> asked for 100,000 tokens which the buyer agreed to pay.  After you
accepted the
> offer you proceeded to sell the tokens at a discount to get rid of them
quickly,
> and
> you only got $1.25 each for a total of $125,000.  Also assume the buyer
borrowed
> the
> tokens to make the purchase.  This is now an example of a large short
seller
> (same as a
> borrower) driving down the value of the tokens.  One could say the
availability
> of credit
> caused the NYC tokens to drop in value via a large borrower who
subsequently
> spent
> his tokens.  You could also say the buyer drove the price of the house
from
> 87,500 tokens
> to 100,000 tokens.  But note that as long as NYC sticks to its price of
$1.50
> per token and
> demand continues as before the price will return to the $150 level.
>
> Note also that the ability to borrow tokens in unlimited amounts without
> collateral or
> any other security will quickly render them worthless.  In the above case
the
> credit
> advanced must somehow be limited, either by collateral demanded or some
form of
> coercion to cause the borrower to subsequently offer real goods and
services to
> repay
> his loan.

Per says:
Subway tokens in all honour, but a national currency does not operate on the
same principles. The analogy is halting to say the very least. For one
thing, in order for your example to work, all prices will have to be
specified in terms of subway tokens, you need contractual enforcement,
legal-tender laws, etc. in terms of subway tokens. The most important
objection, however, is that people obtain subway tokens because they expect
to ride the subway and derive whatever 'utility' or satisfaction one can get
out of that experience.

The analogy, then, would amount to that people work for the government (to
get paid in currency) in order to enjoy the public services provided by the
government. I guess one could add here that since the public services as
such as free of charge, compulsory taxation will substitute for the token
slots at the turnstiles. Limping analogy.

More importantly, however, the fact that the government takes back through
taxation and other 'reflux' mechanisms what it hands out in wages and other
expenditures does not add one iota to the understanding of the mechanisms
that determine the 'value' of this currency - meaning its purchasing power
in terms of goods and services. We have established before that the claim
that it is the 'prices that government pays' on the stuff it buys that
'determines' this value is circular and/or tautological. Which leaves open
the question what else there is that determines its value? I'm afraid that
repeating the mantra of the 'vertical component' does not add much to this.

Best,
Per

_____________________________________________
Per Gunnar Berglund
CEPA    80 Fifth Avenue, 5th floor    New York, NY 10011
Tel: (212)229-5923    Fax: (212)229-5903