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Monthly Archives: September 2011

Operation twist is the media name for the Federal Reserve’s latest round of asset buying.

According to the Fed, they will be buying longer term (mostly 10 year) treasuries and selling shorter term bonds.  In addition, they will be reinvesting dividends from their asset backed securities purchases (from QE1) into additional mortgage backed securities.

The effects, although somewhat muted, will be noticeable.  This is the Fed throwing in the kitchen sink.  Long term interest rates will come down some, although not a huge amount.  If the 10-year bond falls closer to 1%, that will be a sign the economy has tipped back to recession.  Even with a low-growth scenario, Operation Twist is perhaps enough to bring fixed mortgage rates below 4% and create another round of refinancing.

This is both good and bad for banks.  The good is that a lot of questionable mortgages will get refinanced into more stable loans.  The bad is that it makes banks less profitable.

I don’t see the sales of short term bonds having much effect, as demand for short term bonds is already high and the Fed controls interest rates of that duration anyway.

The purchases of asset backed securities will also help banks clear up room to provide more lending.  Whether or not they will have a lot of profitable opportunities to do so is another question.

Finally, it must be noted that there is some deflationary effect from this.  As bond interest rates go down, there is less interest income going to the private sector.  This hurts savers who are spending out of their retirement incomes.  Interest rates are always a two-way street.  Yes, declining interest rates create demand for credit.  But it also dampens overall aggregate demand because there is less interest income in the economy.

Overall, risks remain high.  The large deficit continues to work its magic by allowing households to reduce debt, but demand remains weak and unemployment tragically high.


If the government was a household.

If the government was a household, it would have to balance it’s income with its expenses.

If the government was a household, it would at least have to have income commensurate with its debt payments.

If the government was a household, it wouldn’t be able to afford all that waste.

Except, the government isn’t a household.

The government has a printing press which allows it to create dollars to make its interest payments.

The government doesn’t need income in order to spend.

The government doesn’t need to balance its income with its expenses.

In fact, when the government balances its income with its expenses, recession and depression nearly always result.


Chartalism is an economic theory which says that money is given value through its use as payment of taxes to the state.  Charta- means token or ticket:  items which have no intrinsic value but are given value by their acceptance as payment in exchange for goods or services.

Metallism, or “commodity money” says that the unit of account will have an intrinsic value; that is, it will have value apart from its use as a medium of exchange.  The Gold Standard is an example of metallism.

Chartalism was developed by G.F. Knapp in the early 1900′s and was used by Abba Lerner in developing Functional Finance.  Modern Chartalism is referred to as Modern Monetary Theory (MMT).


In a previous post, we defined “sound money” as the practice of Governments to balance their budget over the business cycle.

Understanding why sound money principles lead to recession and depression requires an understanding of “sector balances.”

In a nutshell, the budget balances of the Government, domestic private sector and foreign sector will net to zero.  If we assume a balanced trade account (imports=exports) then the government surplus will exactly equal the private sector deficit.  Conversely, a government deficit will exactly equal the private sector surplus  (I had demonstrated this in the post linked to above, so you can go there and see it for yourself).

Once we have this, we can understand that when the Government runs consistent surpluses, the private sector will be in jeopardy.

Let’s say, for example, the Government runs a surplus of $200 billion for 3 straight years, and that the trade balance is neutral (imports=exports).  If this is the case, the private sector will have spent $600 billion more than they earned over the same period.  In order to keep up their spending, the private sector will be forced to either spend down existing savings or increase their borrowings by the same amount.

For reference, the last time the US ran consistent surpluses prior to the late 1990′s was the late 1920′s, just before the Great Depression.

This is why Governments very rarely run surpluses, why they never pay off the National Debt –the one time the US did this, in 1835, a particularly nasty depression resulted–and why attempting to run down deficits during a downturn in private credit creation, such as now, is a recipe for disaster.




The Gold standard is the practice of Governments to fix their currency to the price of Gold, and to offer to exchange their currency for an equivalent amount of it.

For example, if the price of the currency was set at $100 per ounce of gold, then $1 would be worth and exchanged for 1/100th of an oz. of gold.

Other commodities or a basket of commodities could also be used to set the price of the currency.

The United States officially went off the Gold Standard in 1971.

Sound money is the concept of the Government balancing it’s budget over the business cycle  (Typically represented as one year).

In Austrian economics, sound money is tied to a commodity money regime, such as the gold standard.  When used this way, Government spending is limited by the amount of gold in the world (and held by the Government) which prevents runaway spending and inflation.

In a fiat money regime (absent the gold standard), there is no such limitation. Governments are operationally unconstrained in their spending, so political, social and ideological constraints are placed upon Governments to prevent profligate spending.

Nearly all modern Governments profess a goal toward sound money.  In addition, nearly all economists, conservative and progressive alike, profess sound money principles to be a natural law of economics.

Very few Governments actually achieve it in practice.  The reason for this is simple: a growing economy requires a growing supply of money.  The only other way  for the money supply to grow is for entrepreneurs to spend bank credit.   When sound money principles are put into use, recession, depression and volatile business cycles are the result.


An ELR (employer of last resort) program is a government jobs program to employ labor for which there is no bid in the private market. An ELR program would provide a “buffer stock” of jobs to ready, willing and able labor; typically at some minimum wage.

Proponents of a job guarantee argue five primary points:

1.  The job guarantee would allow unused labor resources in the economy to match up with needed infrastructure improvements such as building bridges, roads and levees.  This would provide greater infrastructure for private sector activity.

2.  The job guarantee would allow for greater price stability in the economy.  As there is effectively “no bid” for the labor, government could spend modestly on a program without causing inflation.  Furthermore, as the economy improved and workers transitioned back to the private sector, the job guarantee program would employ fewer workers and result in less government spending.

3.  The job guarantee would allow for a greater level of economic activity in the economy, increased spending on other goods and services and cushion against downturns; preventing many personal bankruptcies and foreclosures.

4.  The job guarantee would enable the government to spend less on other “welfare” type transfer payments and keep the skills of employed workers sharp, enabling them to more easily transition to private sector employment when growth resumes.  In addition, “need” based crime would be reduced.

Finally, proponents argue, a job guarantee is the only way to to fully close the spending gap (resulting from government taxes and private savings) and eliminate unemployment.

Warren Mosler, a former candidate for Senate in Connecticut, proposes an $8 per hour wage here.

For more information on how a job guarantee could be implemented, see  here and here.