So I started brainstorming the issue with my partners. We knew no nation had ever defaulted in its own currency with a floating exchange rate policy, and defaults only came with gold standards, fixed exchange rates, external currency debt, and indexed domestic debt. But why? The answer given was ‘because they can always print the money.’ Fair enough, but no one ever did ‘print the money,’ so there must be a better reason.

A few days later when talking to our research analyst, Tom Shulke, it came to me. I said ‘Tom if we buy securities from the Fed or Treasury, functionally there is no difference. We send the funds to the same place (the Fed) and we own the same thing, so functionally it has to all be the same. Yet presumably the Treasury sells securities to fund expenditures, while when the Fed sells securities it’s a reserve drain to offset operating factors and manage the fed funds rate. Obviously in fact they are the same- it’s all just a glorified reserve drain!’

Not long after that Maurice Samuels, then a portfolio manager at Harvard Management, set up meetings in Rome with officials of the Italian government to discuss these issues. The pivotal meeting was with Professor Luigi Spaventa at the Italian Treasury. I opened with ‘Professor Spaventa, this is a rhetorical question, but why is Italy issuing Treasury securities? To get lira to spend or, rather, because if you don’t issue securities, the lira interbank will fall to 0 when your target rate is 12%?” Professor Spaventa at first looked puzzled, not prepared for that kind of question, then took a minute to think about it, and replied, “no, the interbank rate would only fall to ½% as we pay ½% interest on reserves.” Perfect answer for us- here was a Finance Minister who actually understood monetary operations and reserve accounting! A few seconds later he jumped up out of his seat proclaiming “Yes! And they (the IMF) are making us act pro cyclical! A 20-minute meeting went on for two hours as he called in his associates, and made cappuccino for us before we had to run to the next meeting. A week later an announcement came out of the Italian Ministry of Finance- ‘No extraordinary measures will be taken. All payments will be made on time.’

We and our clients were later told we were the largest holders of Italian lira denominate bonds outside of Italy, and managed a pretty good few years out of that position. Italy did not default, nor was there any solvency risk.  Insolvency is never an issue with non convertible currency and floating exchange rates.

Author: Warren Mosler

For other Economists’ support click here

For other Economists’ support click here

For other Economists’ support click here

While the tax payment has no further effect on the net worth of the private sector (dollars are paid while a tax liability is written off), it cancels a government’s claim (thus reducing the ‘government deficit’ for the period), and simultaneously reduces the net financial assets owned by the private sector.  If the government returned the tax paid (as it happens with a tax credit), the deficit will increase and the private sector net financial assets will increase dollar-by-dollar.

Therefore, for any change (increase or decrease) in the government deficit, there is an identical change in the net financial assets (or financial surplus) of the private sector.  On the other hand, the US private sector may decide to make some purchases from foreigners.  In this case, the US private sector’s financial surplus will fall, while foreigners’ financial surplus increases. Foreigners receive dollar payments in the form of bank account balances in the US system, so as long as they decide to store dollars they own an account in the US.

For other Economists’ support click here

• An ECB distribution to European States entails no issuing of debt;

• Taxing functions to regulate demand, it does not actually collect revenue;

• When China buys US Treasury securities, it makes no specific resource available to the United States: just moving a credit entry from one account to another;

And if you think: “oh, this is ridiculous, it just can’t be so easy!” think again and seek some answers on this website.

Please click here to watch the video footage of Warren Mosler on CNBC on 11 February 2010.

Aiming at public purpose while reducing government discretionary power, increasing spending power, fixing the banking system, restoring states’ budgets, keeping inflation in check, achieving full employment, easing tensions in the mortgage market, and ensuring sufficient liquidity at all times.

1.  A full payroll tax holiday where the US Treasury makes all FICA payments for us.  The restored spending power allows households to make their mortgage payments, which ‘fixes the banks’ from the ‘bottom up.’  It also helps keep prices down as competitive pressures will cause many businesses to lower prices due to the tax savings even as sales increase.

2.  A $500 per capita Federal distribution to all the States to sustain employment in essential services, service debt, and reduce the need for State tax hikes.  This can be repeated at perhaps 6 month intervals until GDP surpasses previous high levels at which point state revenues that depend on GDP are restored.

3.  A Federally funded $8/hr job for anyone willing and able to work that includes healthcare.  The economy will improve rapidly with my first two proposals and the private sector far more readily hires people already working vs people idle and unemployed.  In 2001 Argentina, population 34 million, implemented this proposal, putting to work 2 million people who had never held a ‘real’ job.  Within 2 years 750,000 were employed by the private sector.

4.  Return banking to public purpose, by banning all banking activities that do not serve public purpose. Banks should no longer engage into secondary market transactions, proprietary trading, lending vs. financial assets, business activities beyond approved lending and providing banking accounts and related services, contracting in LIBOR (only fed funds), subsidiaries of any kind, offshore lending, contracting in credit default insurance.

5. Reorganize monetary policy by having the Fed lend in the fed funds market to all member banks to ensure permanent liquidity.  Demanding collateral from banks is disruptive and redundant, as the FDIC already regulates and supervises all bank assets.

6. Remodel the Treasury securities market, by having the Treasury issue nothing longer than 3 month bills.  Longer term securities serve to keep long term rates higher than otherwise.

7. Improve the FDIC by removing the $250,000 cap on deposit insurance (liquidity is no longer an issue when fed funds are available to solvent banks), and by not taxing the good banks for losses by bad banks (all that does is raise interest rates).

8. Adopt new practices in the mortgage market by having the Treasury directly funding the housing agencies to eliminate hedging needs and directly targeting mortgage rates at desired levels.  Likewise, homeowners being foreclosed should have the option to stay in their homes at fair market rents with ownership going to the government at the lower of the mortgage balance or fair market value of the home.

9.  Remove the ’self imposed constraints’ (relics from the Gold Standard) that are disruptive to operations and serve no public purpose by eliminating ceilings on US Treasury debt denominated in dollars, and by reinstating US Treasury ‘overdrafts’ at the Fed.

10. Increase Federal taxes only to cool down an overheating economy, and not to ‘pay for’ anything (as taxes function to regulate aggregate demand, not to raise revenue per se).

When: Tuesday April 20, 2010

Where: Franklin Auditorium

Program to be posted soon.

Includes Keynote Speaker: Peter Clarke, Emeritus Professor of Modern British History, Cambridge University, Pragmatic and Dogmatic Keynesianism: The Relevalence of Keynes.

All students meeting the following requirements are invited to apply:

a) Junior or senior class standing by May 2010 (at Franklin College Switzerland or other accredited institution);

b) Significant progress in upper-level Economics.

Students who are considering this opportunity are advised to preliminarily contact Prof. Andrea Terzi (aterzi@fc.edu), so you can find out more about what the project entails. Students who will confirm their interest will be requested to submit their application, including a brief letter stating the reasons for their interest and describing their intended project in a two-page research outline.

Prior scholars have worked on Policies at the Intersection of Unemployment and Poverty (Zachary Levy) and The Effectiveness of Fiscal Policy Lessons from Japan 1990-2007 (Roxana Cazacu).

Please contact Professor Terzi (aterzi@fc.edu) for additional information or assistance.

The total amount of bank deposits has nothing to do with the saving attitude, or with the spending decisions, of bank accounts’ holders. A new bank deposit can only be created through two main channels. In one, deposits are born twins with bank loans to the non-bank private sector (households or firms). In the other, deposits are born twins with bank reserves as a result of payments made by the public sector (Treasury or Central bank) to the non-bank private sector. A third process, yet smaller in importance, is when the banking sector makes net payments to the non-bank private sector.

The bank loan channel: This is when a bank makes a new loan.

Once the new balance is made available to the client-borrower, this will increase the total deposits in the banking system. By the end of the day, the banking system has more loans in its portfolio (assets) and more deposits to honor (liabilities), while the non-bank private sector has more deposits (assets) and more loans due (liabilities). In the process, the total amount of reserves held by the banking system has not changed.

Conversely, the total amount of deposits declines when the non-bank private sector makes any payments to a bank (such as interest payments, loan principals, or a purchase of a bank product).

Thus, for any time period, the net creation of deposits through this channel equals the amount of bank loans made to the non-bank private sector net of principals and interests payments received.

Public sector’s payment channel: This is when the public sector sends a check to the non-bank private sector.

If the check is issued by a national state with monetary sovereignty (i.e., the unit of money issued is a national state liability not pegged to any other asset the nation state must hold as guarantee), than the check will never bounce. When the non-bank private sector’s recipient deposits the check, the banking system acquires an equivalent amount of reserves via a credit entered by the central bank. By the end of the day, the banking system has more reserves (assets) and more deposits to honor (liabilities), while the non-bank private sector has more deposits (assets).

Conversely, the total amount of deposits declines when the non-bank private sector makes any payments to the public sector (such as taxes, or purchases). Thus, for any time period, the net creation of deposits through this channel equals the amount of all government and central bank net payments.

The banking system net factor: This is when a bank makes a payment to the non-bank private sector for reasons other than making loans, such as payments of salaries to bank employees, rents paid to landlords, interests paid to depositors, dividends paid to shareholders, and any other outlays (for current output, existing real assets, or outstanding financial assets). By the end of the day, the banking system has settled a number of its liabilities by creating deposits in the name of the payees, and the non-bank public has more deposits (assets).

Conversely, the total amount of deposits declines when the non-bank private sector makes any payments to the banking system (such as fees).

Thus, for any time period, the effect of this channel equals the outflow of funds of total banks’ expenses net of total banks’ receipts.