The author at 54 quotes historian Glyn Davies as saying "[A] fiscal framework [in 1914] had . . . transformed on the eve of [WWI] into a much more buoyant source of revenue, ripe for the insatiable demands of the military machine. [The program of state spending created for] welfare thus became a timely godsend for war."
The scholarship of Peter Wilson on the 30 Years' War and its long-term influence also supports the welfare-warfare argument about the purpose of the modern state. Welfare isn't really about welfare just like central banking isn't really about low inflation and low unemployment. It's about disciplining a large population for high taxation, conscription, and the other sacrifices associated with modern war.
I'm really averse to teleological explanations of evolutionary processes. They smack of "the purpose of life is to increase complexity."
But even if it were true that each and every change in the financial system regulation has made it easier for the Federal Government to issue debt (reduced the interest rate of government debt relative to private debt) that still woud not be a guide as to whihc of those regulation to change or which taxes and expenditures to change to achieve a "better" total debt. [Yes, the quotes are sarcasm. I think reasoning from debt toward expenditure/taxes is totally upside down.]
Well, the silver lining to the Federal Reserve coming right out and pledging to use all of the tools at its disposal to block or sabotage everything and anything that might benefit the Republicans in 2025 is that we can all finally retire the tired myth of Fed independence being some kind of public benefit. Just as with the federal bench and the federal “civil” service, notion of a “rule of law” is a farce. These clowns have their own agenda and will not submit to any constitution, law, or elected official however popular or legitimate.
If the Republicans really see taking a run at Federal Reserve reform as being potentially worth the time and effort, they might do worse than to take Stephen Miran’s proposals to reform Fed governance serious consideration. (https://www.realclearmarkets.com/authors/stephen_miran/ )
For example:
“Congress should amend the Federal Reserve Act to shorten all board members’ and Reserve Bank leaders’ terms to a single term of eight years. These terms should not be fixed calendar-year terms but, rather, terms of eight years from the time of confirmation by the Senate. Additionally, board members and Reserve Bank leaders should be subject to at-will removal by the president to ensure their accountability to the democratic process.”
and
“The Reserve Banks should be formally nationalized to make clear that these are government institutions that are accountable to the American people.”
and
“Under our proposal, the voting structure balance between the board and the Reserve Banks on the FOMC changes dramatically, from 7–5 in favor of the board to 12–7 in favor of the Reserve Banks.”
And yes, ending quantitative easing “would make it harder for the government to keep mounting up its deficit. For the long-term welfare of ordinary Americans, this would probably be a good thing.” But the new Congress could also simply stop mounting up more deficit. If there is no need to borrow, then there is no need for the Fed.
another Miran policy proposal of which I have grown enamored. In very short summation, Miran offers supply side reforms that would “make producing in the U.S. much cheaper. Policymakers should relax and streamline rules, making them more targeted across the regulatory state. The status quo is smothering innovation and keeping too much industry overseas.” (https://www.city-journal.org/article/how-to-build-american-right ) Every so called “free trade” economist will tell you that such an agenda is impossible and that the one true future for the United States is a service economy with 90% of the population working minimum wage jobs. Something like 50% of college graduates wind up working jobs that don’t need a degree with something like 10% becoming baristas. This need not be the future. All the new server farms need enormous amounts of of new electrical transmission equipment for which there are multi-year backlogs in orders. Why can’t that be built here? Whatever it is that is holding back that from happening, fix it. Similarly, one of the few useful things that AI has apparently managed to accomplish is finding new materials. (https://phys.org/news/2024-07-ai-approach-materials-discovery-stage.html ) Well why can’t these new materials be put to actual use in making things in the US? Whatever it is, fix it.
Anyway, as they say, I like the cut of this fellow Miran’s jib. Hope somebody in White House Personnel has the good sense to recruit him.
No doubt you know far more about banking and in far greater detail than me yet maybe for the first time I find myself doubting far more than small points or your frequent pessimism.
1 You made a rather flippant remark about financial crises before and after creation of the Fed but other than the obvious exception of the Great Depression, it's my understanding that since creation of the Fed in 1913 we've had less and smaller financial downturns than 50+ years before the Fed (back to Jackson?). Can anyone add detail to that?
1a One could argue the Fed made mistakes worsening the Great Depression and 70s recession/inflation (until Volker) but it seems to me they have done quite well in the past 50 years despite some bank regulation mistakes leading to downturns that don't seem attributable to the Fed.
2 Quantitative easing after the Great Recession massively expanded the money supply yet we didn't get inflation. I can think of a couple possible reasons why not. Regardless, how would you reduce the QE holdings? Contracting the money supply might have had some benefit when inflation was high but that isn't helpful now, is it? The only alternative I know is selling bonds and printing money. Isn't that essentially a wash?
2a You've written before about the Fed "losing money" by holding bonds at low interest rates and paying on bank reserves at higher rates. How is this worse than printing money and paying interest on bank reserves?
2aa (aside) I've read explanations a few times but I still don't understand what was gained by paying interest on bank reserves held at the Fed, especially excess reserves.
3 If I'm not entirely mistaken, US gets a huge benefit from the dollar being an international currency of exchange. I've never read about the connection but it seems to me that without the Fed, this would be extremely unlikely.
3a Capital in US is cheaper and more available than in the rest of the world. This seems an important contributor to exceptional growth of our economy and our leadership re innovation vs the rest of the world, at least the most developed countries.
3aa US borrows at very minimal cost above inflation. (Inflation increasing interest cost and decreasing real debt about equally.) Given everything, is this likely to change?
When Congress gets through with it, "abolishing" often means changing the name and the organization chart, splitting and consolidating, but leaving things remarkably like they were before the "abolishment".
Arnold, no doubt this is a kindergarten question but ... I assume that without the Fed, the US government would finance deficits by selling debts (bonds) to the public. Now, with the Fed, it sells debt to the Fed, which then sells it to the public. Why does the second make it easier to sell government debt, and thus make large spending easier?
There is a hilarious YouTube video called quantitative easing explained. The Fed does not buy from the treasury that would be cheaper instead the treasury sells to primary dealers who turn around and sell to the fed.
I found a video called Quantitative Easing Explained, 6:48, two cartoon figures doing text to voice. I though some of it was kind of stupid, but the part about, would it be cheaper to buy directly, was pretty funny in a maddening sort of way.
Not about the Fed but one of the videos that came up after it was over was "Trump will lose the election by five percent--this is what cost him, Diane Francis (who is described as a "veteran journalist")" from (New York) Times Radio 7 days ago, so the day before the election. My gut feeling was, "My, God, she really believes all that. She lives in a bubble of like-minded people and just can't think any other way." She's also into the hate, honestly believes Donald Trump is majorly racist/sexist/homophobic, which of course makes hating him a moral necessity.
The fed does not buy directly from the treasury. Fed buys from the primary dealers and what are called open market operations, the primary dealers by from the treasury. There is a hilarious YouTube video called quantitative explained which does a great job with this
It wouldn't you'd just need a separate Bureau of the Treasury buying and selling stuff to try to keep inflation on a real-income maximizing trajectory. And it would be more prone to over target inflation to keep Treasury borrowing costs lower.
Or even worse the Chinese system of telling State banks what to do.
Wow! Arnold has written the highlights of the monetary and fiscal history of the US in a nutshell. Clearly the Fed, whatever the original intent, has enabled the gross fiscal irresponsibility of the welfare-warfare state, and monetizing the deficit has become its overriding function. I wonder however, whether there is any longer a possibility let alone any will to reduce deficits to the point that they can be covered by growth. I suspect we have created entitlements that far exceed our ability to finance them by any politically imaginable system of taxation that would not wreck the economy. Controlling spending sufficiently to make any difference is a political non-starter. People actually believe they have fully earned their entitlements, even though amounts paid in are trivial in relation to what is paid out. It seems to me that the most likely outcome will be to try to limit the federal debt burden by maintaining a high level of inflation, with a risk of that getting out of control leading to eventual political catastrophe in some unpredictable form. No doubt inflation was a big issue in the recent election, but if people didn't like that, they really wouldn't like the huge broad tax increases and entitlement cuts needed to actually fix it. And even if that somehow happened, our political system would immediately set about undoing it.
Meanwhile, we see other non Western-aligned nations, including Russia, which don't have anything like these problems.
They do have these problems, and other problems besides. Putin's triumph over his rivals involved credibly promising to maintain very expensive boomer pensions while growing the domestic economy, diversifying away from commodity production, and maintaining the military. Russia's at ~20% government spending of GDP and the US is at 15.5%.
China's challenge is to maintain growth while also systematically suppressing rates of saving and investment among other issues. What sucks for China is that your incentive when you get rich is to smuggle your capital out of the country to invest in your rival's markets. In the US our incentives are to save in our markets and to spend externally because of our high regulation and very bad domestic purchasing power.
& for the 1st time servicing this debt has become the largest line item in the US government's P&L-bigger than the DoD, Medicare or Social Security.
& to Arnold's consternation, this will only increase exponentially in the future.
“Any great power that spends more on debt service than on defense will not stay great for very long. True of Habsburg Spain, true of ancien régime France, true of the Ottoman Empire, true of the British Empire, this law is about to be put to the test by the U.S. beginning this very year.” Niall Ferguson
Trees don’t grow to the sky forever and neither will US deficits. Whose set of problems would you rather have? The US has major entitlements problems, but those can all be (at least theoretically) wriggled out of without fundamentally changing the structure of the economy.
Agreed. They will inflate to monetize the debt, kicking the can as long as they can. A tiny quibble: Some people believe they earned their entitlements, true; but I think more people just want what they were promised. And I think most people didn’t even ask for what they were promised. Some asked for it, it was shoved down everyone’s throats.
"I suspect we have created entitlements that far exceed our ability to finance them by any politically imaginable system of taxation that would not wreck the economy."
You lack imagination. :) We could finance the social insurance package and even strengthen it with more generous unemployment benefits and a child allowance with a VAT. And however politically unimaginable it is, it woud damage the economy less than the current system of wage tax + deficits.
He said "politically imaginable". The fact that you, a smart person at 30,000 feet, can imagine a different system doesn't mean that it has any chance of being adopted without a big fight and lots of anger and disappointment.
I thought the Riksbank back some time in 1600's was first Central Bank?
Creation of the Fed seems to have been more politically driven by tiredness with all the bank failures in late 1800's and last one in 1907. Yes, some truth to Ferguson's view.
I personally am a fan of some rules based system whether it be along the lines of a Taylor Rule or NGDP framework. Just seems too much discretion on the part of humans and too many PhD macroeconomists who seem too often to not get things right.
I favor FAIT. Although you can argue about how fast the Fed should bring inflation back down to target after facilitating adjustment to a shock, I would not try to make up a rule.
So, negative nominal ST rates? Buying foreign exchange? What do you do want the Fed to do when inflation is too low? [Personally, I'd have them buy Trillionths, if the Treasury woud issue them.]
Whether or not QE was appropriate when it was initially implemented, I don’t think I’m qualified to say.
But like AK, I am convinced that it went on for far too long, and that it likely has, and surely will, have net negative consequences when done for so long.
I’m a Taylor rule guy myself, and I’d be very amenable to Scott Sumner’s NGDP targeting.
Less flexibility for the Fed - even if it m ight need to be more than zero - would be a better thing.
P.S. please tell me for exactly how long inflation was “too low”, and what your definition of “too low” exactly is. For me, above 0.7% annually is *not* too low, and 1%-2% is an excellent target range.
There is little disagreement among (non-Marxist) economists that central planning leads to bad results, mostly due to what Mises called the information problem. Yet everyone has an idea to “fix” the most egregious example of central planning’s failure, central banking. This is nuts. The solution to inflation and currency debasement is the separation of money and state. We need a medium of exchange that government can’t screw with. Unfortunately, crypto likely isn’t it, since barely a week goes by without a news story about some cryptocurrency king who woke up one morning to discover how e-wallet hacked and his cryptocurrency vanished.
Optimized inflation. That sounds like one of those leftist notions like “fair share”, as in, making “the rich” pay their fair share of taxes. What, pray tell, is the optimized rate of inflation, given that in reality, any rate above zero is destructive? The Bank of Canada aims to hold inflation to a 2-3 percent range, which merely cuts consumer purchasing power in half every generation, and they are widely seen as an “inflation fighting” central bank.
The idea is that people have major "loss aversion" but they also don't notice 2-3% inflation. In a changing world, demands for goods and labor are always changing. Which means they are always some going down. But people really resist taking arithmetically less than they used to. This leads to unemployment (if the price of your labor is too high for the demand, less will be bought) and recession. An economy with no inflation is inevitably prone to low or no growth. So there has to be a way to lower prices for goods and labor that isn't explicit. That's 2-3% inflation.
I know I've done a terrible job describing the idea there. It's basically a "second best" solution "It would be great if prices were perfectly flexible but ..." The best job I've seen explaining--and criticizing--the rationale is Tim Harford's (poorly titled) The Underground Economist Fights Back: How to Run or Ruin an Economy.
I get that argument. But I think Dominic Frisby came up with the ultimate weapon against inflation, namely, the separation of money and state. We need a medium of exchange that politicians can’t fuck with, as that fuckery is the veritable font of inflation. As for central banking, despite having spent 30 years in the bond market, I am still waiting for someone to explain to me how that is any different from central planning?
Well, for 200 years from the start of the Industrial Revolution, with no central banks and the world on the gold standard, there was essentially no inflation. That sounds fairly optimal to me.
The recourse rule did not lead to the crash of the mortgage bond market. Free insurance on the bonds (the guarantee by the Fed) did. We were already talking about it where I traded a buy side quant fund in the late 90s.
Might there be some populists in the new administration, even the President-elect, who will come after the Fed? They might advocate for reducing the Fed balance sheet or perhaps a return to the gold standard?
The Fed could certainly reduces its balance sheet but it might interfere with keeping inflation on target. I don't see how that is "populist" much less good for the economy.
Your correct last sentence is also why it ain’t gonna happen—most voters, most of the time, prefer benefit in the short term. Or, to make the long term benefit palatable, the govt will have to bribe the people with something short term.
There also the myth that the Fed is not part of the govt, which is barely true, legally, but essentially false. When do we Audit The Fed? As Ron Paul asks; is an audit needed?
What is needed is a population who do not want govt to borrow so much. Like a Balanced Budget Amendment—which doesn’t seem to be on Trump’s table, nor any Party except the Libertarians. It will be necessary for big spending Dems to favor limits before any are enacted.
A realistic change is to have the Fed only focus on price stability, with raising & lowering interest rates to reduce inflation or deflation. The Congress should have more direct unemployment responsibility. There should be an explicit, Congress controlled, Banking Regulatory Commission for regulating banks, only, and especially Big Banks; maybe under the Treasury.
"It will be necessary for big spending Dems to favor limits before any are enacted."
And big "tax cuts for the rich" Republicans, too. I never hear people who grouse about "big spending" say exactly what they want to cut by how much. [Mine are farm and ethanol subsidies.]
So the Fed was created to try to stop the "bank panic" phenomenon so familiar in the 19th century?
It's weird that the solution to banks lending too much money, is another bank behind them to back their play.
This was a very interesting and cogent piece, which I appreciate, but I can't help but notice that none of this has anything to do with capitalism; rather it is all to do with unwarranted assumptions about capitalism.
I’d say fix the trade deficit and then the need for government deficits goes down. If you cut federal deficits without adjusting the trade balance you’ll just get increased private sector debt (which is looking healthy right now) or really high unemployment.
Of course the basic arithmetic of aggregate financial flows must balance the pools of debt and credit when any one has a significant change. Nevertheless, with "safe debt" as with anything, when anyone complains about shortages they are usually being incoherent and just whining about price. The only need is that of the government to fund its reckless deficits, and it would be better if the Fed was dedicated to making this more difficult instead of making it easier.
You have the causation exactly backwards unless you mean tax imports enough that the revenues reduce the deficit. That is just about the worst possible tax to increase to reduce the deficit. I guess that's why Trump likes it so much. :)
This publication from the Army War College supplements your thesis: https://press.armywarcollege.edu/monographs/455/
The author at 54 quotes historian Glyn Davies as saying "[A] fiscal framework [in 1914] had . . . transformed on the eve of [WWI] into a much more buoyant source of revenue, ripe for the insatiable demands of the military machine. [The program of state spending created for] welfare thus became a timely godsend for war."
The scholarship of Peter Wilson on the 30 Years' War and its long-term influence also supports the welfare-warfare argument about the purpose of the modern state. Welfare isn't really about welfare just like central banking isn't really about low inflation and low unemployment. It's about disciplining a large population for high taxation, conscription, and the other sacrifices associated with modern war.
I'm really averse to teleological explanations of evolutionary processes. They smack of "the purpose of life is to increase complexity."
But even if it were true that each and every change in the financial system regulation has made it easier for the Federal Government to issue debt (reduced the interest rate of government debt relative to private debt) that still woud not be a guide as to whihc of those regulation to change or which taxes and expenditures to change to achieve a "better" total debt. [Yes, the quotes are sarcasm. I think reasoning from debt toward expenditure/taxes is totally upside down.]
Well, the silver lining to the Federal Reserve coming right out and pledging to use all of the tools at its disposal to block or sabotage everything and anything that might benefit the Republicans in 2025 is that we can all finally retire the tired myth of Fed independence being some kind of public benefit. Just as with the federal bench and the federal “civil” service, notion of a “rule of law” is a farce. These clowns have their own agenda and will not submit to any constitution, law, or elected official however popular or legitimate.
If the Republicans really see taking a run at Federal Reserve reform as being potentially worth the time and effort, they might do worse than to take Stephen Miran’s proposals to reform Fed governance serious consideration. (https://www.realclearmarkets.com/authors/stephen_miran/ )
For example:
“Congress should amend the Federal Reserve Act to shorten all board members’ and Reserve Bank leaders’ terms to a single term of eight years. These terms should not be fixed calendar-year terms but, rather, terms of eight years from the time of confirmation by the Senate. Additionally, board members and Reserve Bank leaders should be subject to at-will removal by the president to ensure their accountability to the democratic process.”
and
“The Reserve Banks should be formally nationalized to make clear that these are government institutions that are accountable to the American people.”
and
“Under our proposal, the voting structure balance between the board and the Reserve Banks on the FOMC changes dramatically, from 7–5 in favor of the board to 12–7 in favor of the Reserve Banks.”
(https://manhattan.institute/article/reform-the-federal-reserves-governance-to-deliver-better-monetary-outcomes )
And yes, ending quantitative easing “would make it harder for the government to keep mounting up its deficit. For the long-term welfare of ordinary Americans, this would probably be a good thing.” But the new Congress could also simply stop mounting up more deficit. If there is no need to borrow, then there is no need for the Fed.
And the easiest way to reduce the need to borrow, is to grow the economy through “robust reindustrialization” (https://manhattan.institute/article/brittle-versus-robust-reindustrialization )
another Miran policy proposal of which I have grown enamored. In very short summation, Miran offers supply side reforms that would “make producing in the U.S. much cheaper. Policymakers should relax and streamline rules, making them more targeted across the regulatory state. The status quo is smothering innovation and keeping too much industry overseas.” (https://www.city-journal.org/article/how-to-build-american-right ) Every so called “free trade” economist will tell you that such an agenda is impossible and that the one true future for the United States is a service economy with 90% of the population working minimum wage jobs. Something like 50% of college graduates wind up working jobs that don’t need a degree with something like 10% becoming baristas. This need not be the future. All the new server farms need enormous amounts of of new electrical transmission equipment for which there are multi-year backlogs in orders. Why can’t that be built here? Whatever it is that is holding back that from happening, fix it. Similarly, one of the few useful things that AI has apparently managed to accomplish is finding new materials. (https://phys.org/news/2024-07-ai-approach-materials-discovery-stage.html ) Well why can’t these new materials be put to actual use in making things in the US? Whatever it is, fix it.
Anyway, as they say, I like the cut of this fellow Miran’s jib. Hope somebody in White House Personnel has the good sense to recruit him.
No doubt you know far more about banking and in far greater detail than me yet maybe for the first time I find myself doubting far more than small points or your frequent pessimism.
1 You made a rather flippant remark about financial crises before and after creation of the Fed but other than the obvious exception of the Great Depression, it's my understanding that since creation of the Fed in 1913 we've had less and smaller financial downturns than 50+ years before the Fed (back to Jackson?). Can anyone add detail to that?
1a One could argue the Fed made mistakes worsening the Great Depression and 70s recession/inflation (until Volker) but it seems to me they have done quite well in the past 50 years despite some bank regulation mistakes leading to downturns that don't seem attributable to the Fed.
2 Quantitative easing after the Great Recession massively expanded the money supply yet we didn't get inflation. I can think of a couple possible reasons why not. Regardless, how would you reduce the QE holdings? Contracting the money supply might have had some benefit when inflation was high but that isn't helpful now, is it? The only alternative I know is selling bonds and printing money. Isn't that essentially a wash?
2a You've written before about the Fed "losing money" by holding bonds at low interest rates and paying on bank reserves at higher rates. How is this worse than printing money and paying interest on bank reserves?
2aa (aside) I've read explanations a few times but I still don't understand what was gained by paying interest on bank reserves held at the Fed, especially excess reserves.
3 If I'm not entirely mistaken, US gets a huge benefit from the dollar being an international currency of exchange. I've never read about the connection but it seems to me that without the Fed, this would be extremely unlikely.
3a Capital in US is cheaper and more available than in the rest of the world. This seems an important contributor to exceptional growth of our economy and our leadership re innovation vs the rest of the world, at least the most developed countries.
3aa US borrows at very minimal cost above inflation. (Inflation increasing interest cost and decreasing real debt about equally.) Given everything, is this likely to change?
"the Fed made mistakes worsening the Great Depression"
It failed to prevent a fall in the price level. Happened again in 2008, but less. Again in 2020 but less. It's improving
Its just prints way more. The US financial system will see a crash like never before and all because of the debt
Just heard on CNBC that Elon Muck wants to abolish the Fed. We are certainly living in "interesting" times.
When Congress gets through with it, "abolishing" often means changing the name and the organization chart, splitting and consolidating, but leaving things remarkably like they were before the "abolishment".
Arnold, no doubt this is a kindergarten question but ... I assume that without the Fed, the US government would finance deficits by selling debts (bonds) to the public. Now, with the Fed, it sells debt to the Fed, which then sells it to the public. Why does the second make it easier to sell government debt, and thus make large spending easier?
There is a hilarious YouTube video called quantitative easing explained. The Fed does not buy from the treasury that would be cheaper instead the treasury sells to primary dealers who turn around and sell to the fed.
I found a video called Quantitative Easing Explained, 6:48, two cartoon figures doing text to voice. I though some of it was kind of stupid, but the part about, would it be cheaper to buy directly, was pretty funny in a maddening sort of way.
Not about the Fed but one of the videos that came up after it was over was "Trump will lose the election by five percent--this is what cost him, Diane Francis (who is described as a "veteran journalist")" from (New York) Times Radio 7 days ago, so the day before the election. My gut feeling was, "My, God, she really believes all that. She lives in a bubble of like-minded people and just can't think any other way." She's also into the hate, honestly believes Donald Trump is majorly racist/sexist/homophobic, which of course makes hating him a moral necessity.
The fed does not buy directly from the treasury. Fed buys from the primary dealers and what are called open market operations, the primary dealers by from the treasury. There is a hilarious YouTube video called quantitative explained which does a great job with this
It wouldn't you'd just need a separate Bureau of the Treasury buying and selling stuff to try to keep inflation on a real-income maximizing trajectory. And it would be more prone to over target inflation to keep Treasury borrowing costs lower.
Or even worse the Chinese system of telling State banks what to do.
I really don't get the "abolish the Fed" folks!
Wow! Arnold has written the highlights of the monetary and fiscal history of the US in a nutshell. Clearly the Fed, whatever the original intent, has enabled the gross fiscal irresponsibility of the welfare-warfare state, and monetizing the deficit has become its overriding function. I wonder however, whether there is any longer a possibility let alone any will to reduce deficits to the point that they can be covered by growth. I suspect we have created entitlements that far exceed our ability to finance them by any politically imaginable system of taxation that would not wreck the economy. Controlling spending sufficiently to make any difference is a political non-starter. People actually believe they have fully earned their entitlements, even though amounts paid in are trivial in relation to what is paid out. It seems to me that the most likely outcome will be to try to limit the federal debt burden by maintaining a high level of inflation, with a risk of that getting out of control leading to eventual political catastrophe in some unpredictable form. No doubt inflation was a big issue in the recent election, but if people didn't like that, they really wouldn't like the huge broad tax increases and entitlement cuts needed to actually fix it. And even if that somehow happened, our political system would immediately set about undoing it.
Meanwhile, we see other non Western-aligned nations, including Russia, which don't have anything like these problems.
They do have these problems, and other problems besides. Putin's triumph over his rivals involved credibly promising to maintain very expensive boomer pensions while growing the domestic economy, diversifying away from commodity production, and maintaining the military. Russia's at ~20% government spending of GDP and the US is at 15.5%.
China's challenge is to maintain growth while also systematically suppressing rates of saving and investment among other issues. What sucks for China is that your incentive when you get rich is to smuggle your capital out of the country to invest in your rival's markets. In the US our incentives are to save in our markets and to spend externally because of our high regulation and very bad domestic purchasing power.
Nebullina has reduced Russia's government debt to $250 billion, despite it waging war against Ukraine.
Meanwhile, the US increases its government debt [$36 trillion] by another $1 Trillion every 90 days.
https://www.usdebtclock.org/
& for the 1st time servicing this debt has become the largest line item in the US government's P&L-bigger than the DoD, Medicare or Social Security.
& to Arnold's consternation, this will only increase exponentially in the future.
“Any great power that spends more on debt service than on defense will not stay great for very long. True of Habsburg Spain, true of ancien régime France, true of the Ottoman Empire, true of the British Empire, this law is about to be put to the test by the U.S. beginning this very year.” Niall Ferguson
Trees don’t grow to the sky forever and neither will US deficits. Whose set of problems would you rather have? The US has major entitlements problems, but those can all be (at least theoretically) wriggled out of without fundamentally changing the structure of the economy.
'Theoretically': For the Kings of wishful thinking
Tell it to the Hapsburgs
& Niall Ferguson.
Agreed. They will inflate to monetize the debt, kicking the can as long as they can. A tiny quibble: Some people believe they earned their entitlements, true; but I think more people just want what they were promised. And I think most people didn’t even ask for what they were promised. Some asked for it, it was shoved down everyone’s throats.
"I suspect we have created entitlements that far exceed our ability to finance them by any politically imaginable system of taxation that would not wreck the economy."
You lack imagination. :) We could finance the social insurance package and even strengthen it with more generous unemployment benefits and a child allowance with a VAT. And however politically unimaginable it is, it woud damage the economy less than the current system of wage tax + deficits.
He said "politically imaginable". The fact that you, a smart person at 30,000 feet, can imagine a different system doesn't mean that it has any chance of being adopted without a big fight and lots of anger and disappointment.
Fights yes, but less economic damage.
" Long-term government debt, supposedly risk-free, generated losses at many banks, including Silicon Valley Bank, which had to be shuttered". [SNIP]
This did not generate losses. Failure to hedge interest rate risk at these banks did.
Btw, there is $500 billion in losses from interest rate risk that US banks are yet to take to account.
Sounds like another bailout-after the LAST bailout in April, 2020 [$3 Trillion]
Fun times!
I thought the Riksbank back some time in 1600's was first Central Bank?
Creation of the Fed seems to have been more politically driven by tiredness with all the bank failures in late 1800's and last one in 1907. Yes, some truth to Ferguson's view.
I personally am a fan of some rules based system whether it be along the lines of a Taylor Rule or NGDP framework. Just seems too much discretion on the part of humans and too many PhD macroeconomists who seem too often to not get things right.
I favor FAIT. Although you can argue about how fast the Fed should bring inflation back down to target after facilitating adjustment to a shock, I would not try to make up a rule.
“chant end quantitative easing.”
End quantitative easing! End quantitative easing! End quantitative easing! End quantitative easing!
So, negative nominal ST rates? Buying foreign exchange? What do you do want the Fed to do when inflation is too low? [Personally, I'd have them buy Trillionths, if the Treasury woud issue them.]
Whether or not QE was appropriate when it was initially implemented, I don’t think I’m qualified to say.
But like AK, I am convinced that it went on for far too long, and that it likely has, and surely will, have net negative consequences when done for so long.
I’m a Taylor rule guy myself, and I’d be very amenable to Scott Sumner’s NGDP targeting.
Less flexibility for the Fed - even if it m ight need to be more than zero - would be a better thing.
P.S. please tell me for exactly how long inflation was “too low”, and what your definition of “too low” exactly is. For me, above 0.7% annually is *not* too low, and 1%-2% is an excellent target range.
There is little disagreement among (non-Marxist) economists that central planning leads to bad results, mostly due to what Mises called the information problem. Yet everyone has an idea to “fix” the most egregious example of central planning’s failure, central banking. This is nuts. The solution to inflation and currency debasement is the separation of money and state. We need a medium of exchange that government can’t screw with. Unfortunately, crypto likely isn’t it, since barely a week goes by without a news story about some cryptocurrency king who woke up one morning to discover how e-wallet hacked and his cryptocurrency vanished.
But then how do we optimize inflation?
Optimized inflation. That sounds like one of those leftist notions like “fair share”, as in, making “the rich” pay their fair share of taxes. What, pray tell, is the optimized rate of inflation, given that in reality, any rate above zero is destructive? The Bank of Canada aims to hold inflation to a 2-3 percent range, which merely cuts consumer purchasing power in half every generation, and they are widely seen as an “inflation fighting” central bank.
The idea is that people have major "loss aversion" but they also don't notice 2-3% inflation. In a changing world, demands for goods and labor are always changing. Which means they are always some going down. But people really resist taking arithmetically less than they used to. This leads to unemployment (if the price of your labor is too high for the demand, less will be bought) and recession. An economy with no inflation is inevitably prone to low or no growth. So there has to be a way to lower prices for goods and labor that isn't explicit. That's 2-3% inflation.
I know I've done a terrible job describing the idea there. It's basically a "second best" solution "It would be great if prices were perfectly flexible but ..." The best job I've seen explaining--and criticizing--the rationale is Tim Harford's (poorly titled) The Underground Economist Fights Back: How to Run or Ruin an Economy.
I get that argument. But I think Dominic Frisby came up with the ultimate weapon against inflation, namely, the separation of money and state. We need a medium of exchange that politicians can’t fuck with, as that fuckery is the veritable font of inflation. As for central banking, despite having spent 30 years in the bond market, I am still waiting for someone to explain to me how that is any different from central planning?
Well, for 200 years from the start of the Industrial Revolution, with no central banks and the world on the gold standard, there was essentially no inflation. That sounds fairly optimal to me.
The recourse rule did not lead to the crash of the mortgage bond market. Free insurance on the bonds (the guarantee by the Fed) did. We were already talking about it where I traded a buy side quant fund in the late 90s.
Franklin Raines was a psychopath.
Might there be some populists in the new administration, even the President-elect, who will come after the Fed? They might advocate for reducing the Fed balance sheet or perhaps a return to the gold standard?
The Fed could certainly reduces its balance sheet but it might interfere with keeping inflation on target. I don't see how that is "populist" much less good for the economy.
Your correct last sentence is also why it ain’t gonna happen—most voters, most of the time, prefer benefit in the short term. Or, to make the long term benefit palatable, the govt will have to bribe the people with something short term.
There also the myth that the Fed is not part of the govt, which is barely true, legally, but essentially false. When do we Audit The Fed? As Ron Paul asks; is an audit needed?
What is needed is a population who do not want govt to borrow so much. Like a Balanced Budget Amendment—which doesn’t seem to be on Trump’s table, nor any Party except the Libertarians. It will be necessary for big spending Dems to favor limits before any are enacted.
A realistic change is to have the Fed only focus on price stability, with raising & lowering interest rates to reduce inflation or deflation. The Congress should have more direct unemployment responsibility. There should be an explicit, Congress controlled, Banking Regulatory Commission for regulating banks, only, and especially Big Banks; maybe under the Treasury.
"It will be necessary for big spending Dems to favor limits before any are enacted."
And big "tax cuts for the rich" Republicans, too. I never hear people who grouse about "big spending" say exactly what they want to cut by how much. [Mine are farm and ethanol subsidies.]
Personnel is policy, most at the Fed are partisan Democrats.
https://x.com/FedGuy12/status/1855255149880705457
So the Fed was created to try to stop the "bank panic" phenomenon so familiar in the 19th century?
It's weird that the solution to banks lending too much money, is another bank behind them to back their play.
This was a very interesting and cogent piece, which I appreciate, but I can't help but notice that none of this has anything to do with capitalism; rather it is all to do with unwarranted assumptions about capitalism.
I’d say fix the trade deficit and then the need for government deficits goes down. If you cut federal deficits without adjusting the trade balance you’ll just get increased private sector debt (which is looking healthy right now) or really high unemployment.
Of course the basic arithmetic of aggregate financial flows must balance the pools of debt and credit when any one has a significant change. Nevertheless, with "safe debt" as with anything, when anyone complains about shortages they are usually being incoherent and just whining about price. The only need is that of the government to fund its reckless deficits, and it would be better if the Fed was dedicated to making this more difficult instead of making it easier.
You have the causation exactly backwards unless you mean tax imports enough that the revenues reduce the deficit. That is just about the worst possible tax to increase to reduce the deficit. I guess that's why Trump likes it so much. :)