Down, down, the cash rate is coming down!
By David Lawson
Click here for excel data: Debtwatch; CfESI
The recent stall in Commonwealth Government Securities on issue will continue to put pressure on the Reserve Bank of Australia to reduce the cash rate. As noted by Glenn Stevens in this weeks Media Release on the June Monetary Policy Decision:
10-year bond yields averaged a decline of 3 basis points per trading day for the month of April. The spread on government bond yields and the Target rate continues to widen.
It is crystal clear that the force behind the demand from investors is the desire for a safe haven when risky assets are so downside volatile, but what about the CGSs supply side of the market? The CGSs market was increasing at an average rate of 3% per month since September 2008, but this growth engine has since stalled. In April Commonwealth Securities on issue declined by 4%, in a period of heightened uncertainty and volatility in the global financial markets. This could be seen as the result of a legislature-imposed supply constraint, given the Australian Federal government’s debt ceiling, as shown in Statement 7 of the 2012 budget:
At a 3% monthly growth rate, CGSs on issue would have surpassed the $250 billion ceiling last month.
With the Australian Federal Government approaching their credit limit, CGSs are inherently feeling the pressure of scarcity, driving up prices and pushing yields down. This is giving weight to somewhat subjective statements about further interest rate cuts this year in the press, whereby the RBA will need to continue cutting the cash rate to follow the trend of government bond yields.
This ceiling is encumbrance on foreign buyers on have brought up large amounts of the CGSs, adding to our official-net foreign debt levels.
Which has also played a primary role in overinflating of the Australian dollar.
Naturally, as interest rates fall following bond yields, the Australian dollar will come back to a more realistic valuation, and we will soon discover that Australia is in fact not different!
Real interest rates in a simple Goodwin model are simply the ratio r= (1-u)/u where u is the wage share of output, and (1-u) is the investment share. Steve Keen incorrectly refers to this type of economy as a barter economy, which is a misnomer. In fact, the Goodwin model describes a cash economy, ie., an economy without endogenous credit. Adam Smith described such an economy where the textile industries in Birmingham and Manchester flourished for 100 years without endogenous credit. Production was financed through discounting of Real Bills.
In a financialized economy, with endogenous credit, there is an additional share of output d which goes to the servicing of debt. Analogous to the real interest rate is the nominal interest rate which can be written i = (1-(u+d))/(u-d). The figure below shows the functional relationships between interest rate vs wage share for various levels of debt d. The top curve is the real interest curve for d = 0 with the lower curves showing increasing levels of d = .05, .1 and .15
Inflation is usually defined in terms of the difference between nominal interest and real interest ie., p’/p = i-r . Collecting terms from the above two equations, a concise formula for inflation can be written for inflation in terms of u and d which is
p’/p = (d(1-2u))/(u(u-d))
An interesting feature of the above curves is that to increase the wage share it is necessary that nominal interest rates go negative.
“interesting” to me implies… unrealistic
In this case I think the assumption that d can be treated as a constant, and independent of u, makes the model behave a little weird in the extremes
“Real interest rates in a simple Goodwin model are simply the ratio r= (1-u)/u where u is the wage share of output, and (1-u) is the investment share.”
The demand for money does not equate to the supply of everything which is not labour, which is what the relationship appears to be attempting to say.
To be true there would need to be no equity.
Retained earnings is a money supply.
The relationship of real assets to liabilities would need to be 1 to 1 which is rarely the case.
etc etc
David Lawson said:
I wouldn’t be so sure of that. Sometimes things take on a life of their own, and a nation’s central bankers lose control, especially if they embrace the quasi-religious faith in only one policy tool being available in the policy-maker’s toolbox–the manipulation of monetary policy–and refuse to use other policy options available to them.
An excellent example is what is currently going on in Switzerland:
“Why Switzerland is the new China”
http://ftalphaville.ft.com/blog/2012/05/31/1023881/why-switzerland-is-the-new-china/
Another example can be found in the United States in the naughties. In 2003, Greenspan (I assume in an effort to cool an overheated economy) started raising the Federal Funds Rate. This, however, had no noticeable effect on 10-year T-bill rates. The Federal Funs Rate in 2003 averaged 1.13%, in 2004 1.35%, in 2005 3.22%, in 2006 4.97%, and in 2007 5.02%. The 10-year T-bill rate was unfazed: 4.01% in 2003, 4.27% in 2004, 4.29% in 2005, 4.8% in 2006, and 4.63% in 2007.
As a result, China managed to dig itself a 2 trillion $US hole, $1.1 trillion in U.S. T-bills and another $800 or $900 billion in asset-backed securities it acquired via the shaddow banking system.
OT, but always relevant, the topic of the following post I made on Mish Shedlock’s forum undercuts a lot of thinking:
Excellent post Mish. The most cogent thing you wrote was “there is a major difference between a bank giving money to players to spend and loans that must be paid back.”
And this (GIVING money to players) of course is exactly what must occur if we are to end this crisis and go on maintaining a modern economy.
We must have a modern debt jubilee as I have posted on here for several years, and as Steve Keen has also come to recognize as the sane and wise way forward. There’s too much at risk not to demand that our financial authorities do exactly that. Away with the authoritarian financial and moral fulminations on all sides, away with the apathetic and overly orthodox prognostications of doom, actions are required. The Chinese or Japanese character for crisis is synonymous I believe with opportunity. The latter expresses the correct attitude required at this moment in time.
Give the both debtors AND savers $50,000 and require them to utilize 75% of it to pay down their debts. If the savers have no debt they get to use the $50,000 in whatever way they choose. (except they can only use 5% of the $50,000 to speculate with). In 6 months rinse and repeat until the major, MAJOR amount of the debt overhang is eliminated. Then, when the reset button has been pushed enough times to revive the “animal spirits” of individuals and businesses, and so that we do not just start the folly all over again by allowing the same authorities and institutions to stumble around in the dark, we must institute a citizen’s dividend and a compensated retail discount. And here is why:
As you Mish have accurately noted there are all manner of reserves sloshing around in Bank vaults, and according to the quantity theory of money and the velocity of its “circulation” there should be more than enough money out there to handle our problems. The problem of course is: 1) Nobody wants to borrow, and those that do the Banks don’t want to see for obvious reasons and 2) money does NOT circulate in the economy what it actually does is flow in a cost accounting cycle from the Banks to producers to workers to retail businesses back to the Banks. In a modern capital intensive economy this cost accounting cycle insures that there will always be less total purchasing power than there are prices. AND NO MATTER HOW MUCH MONEY “RECIRCULATES” IT MUST RE-ENTER THE ABOVE COST ACCOUNTING CYCLE BEFORE IT CAN LIQUIDATE ANOTHER PRICE. COST ACCOUNTING RULES!!!!!!!!!!!! IT CANNOT BE AVOIDED IN THE LEGITIMATE ECONOMY!!!!!!
It took a non-economist C. H. Douglas 90 + years ago to recognize this fact and being free from the orthodoxies of economics and monetary systems was then able to think laterally about it and recommend reasonable solutions. Solutions which of course were contrary to the interests of the Banks and financial authorities (as well as the power intentions and self interests of labor leaders) …..and the rest is history as it is said. In other words the powerful get to talk and those who oppose their power get to walk, walk that is into the noise machine and buzz saw of the powerful’s ability to consciously or unconsciously manipulate circumstance while also choosing the orthodoxies which insure their continued power and control.
Without dogma and in the name of valid human psychology I say: “But God hath chosen the foolish things of the world to confound the wise; and God hath chosen the weak things of the world to confound the things which are mighty;” ( I Cor. 1:27)
The A + B theorem is a reality. And all of the erudite mathematics and all of the unexamined orthodoxy in the cosmos cannot change that fact. The ONLY way to overcome these necessary accounting realities and keep the economy in balance is to issue interest free credit DIRECTLY TO INDIVIDUALS. In other words directly distribute a dividend to individuals, and then also utilize a retail discount to consumers (and a corresponding interest free rebate of that discount back to retailers) to prevent any cost push or demand pull inflation.
Work will still exist and be necessary. Productive investment will go on and its paradigm need not be changed. But cost accounting will always be with us….and an economic sense of grace is its only policy solution.
Glen, First off, I would think most savers have adequate capital to speculate without touching the $50k. Second, it would be unfair to try and keep savers from speculation unless you stopped the big institutions from doing the same. Third, for most overly indebted people, $50k is inadequate.
Otherwise I agree with what you, Mish and Steve Keen say. After much thought, I honestly see no other solution or means of ameliorating the situation the US has found itself in.
In saying that, I still do not believe that the dysfunctional Congress and a President with little recognition of the underlying problems can or will ever chose to do what makes sense. There would also be many uncontrolled and unintended consequences to this course of action. It would significantly reduce income to the Big Bad Bailout Banks plus throw a chaotic wrench into the pension funds throughout the country. It still wouldn’t fix the out of control Medicare imbalance nor the incredible numbers we have in prison nor the dysfunctional political system. It may give the country a slight breathing room but without fixing the underlying imbalances, it would be only a short reprieve, IMHO.
Economicminor,
I’m not sure whether you are addressing my ost of Glenn Stehle’s.
Let me make myself a little more clear on what I recommended in my post.
I recommend the government distribute $50k every 6 months to each family (and perhaps $25k for single adult families). Do this 2 to say 6 times at 6 month intervals until most of the debt of individuals is eliminated or their purchasing power is replaced and returned enough for them to have discretionary money to spend.
Speculation needs to be regulated generally speaking. I’m just thinking that the free money we distribute should be used in the best way and not used as some inflationary way that is an economic vice.
I couldn’t care less whether thew TBTF Banks’ power is diminished. That is precisely what needs to happen in fact. So far as pensions are concerned this is one more very large reason to institute a life long citizen’s dividend which would eliminate the need for debt instruments for pensions. Let equity funds of individual savers’ savings fill that roll if need be. And individuals could place their savings in CD’s or IRA’s.
The crisis is the 800 lb. gorilla of current problems. A simultaneous bailout and a citizen’s dividend and retail discount make the economy and money system hit on all cylinders and transform a non-functioning profit making system into one that not only works well, but places power in the hands of individuals with their sufficient purchasing power money-votes. If the [resident etc. have no clue its up to us to wake him and the financial authorities up. I have no delusions about the difficulties of not only opening their minds to these realities, but then also making it clear that they must indeed execute the legislation that makes it a reality. Nevertheless, the mass social movement which could make that a reality must be created and the battle won. Even though we have but broken straws we must rebuild the world. To do nothing is not an option.
Steve H,
You are right in that I was addressing you.
The time frame of payouts sounds good. I also believe the TBTF or BBBB need curbing and this is a good way. Also the reinstatement of Glass-Steagal needs to be implemented. We need a total seperation between investment banking and savings banks.
As for speculation, once the TBTF are removed from the picture, there is little difference between speculating and investing, especially if/when losers actually lose. Things get out of balance when there are no limits and no real risks, which is where we are today.
I do disagree that the crisis is the 800# gorilla. The reasons and the methods the public came to this crisis is the 800# gorilla. Unfunded promises and unfunded programs plus rampant under reported inflation were at the base of the pyramid ponzi shceme. It wasn’t the banksters acting alone. They needed opportunity and that as provided by the implementation of dysfunctional ideology. Orwell called it DoubleThink. The government wanted to have popular programs which no one wanted to fund and the public wanted benefits and wars without a cost to them.
In the last years, the public had little choice but to borrow. The option of playing or losing gave most little choice. Add in a little human nature of greed and hubris and a crisis was waiting to emerge. Stabalizing the financial end is less than half a fix but better than no fix IMO.
Economiminor,
The crisis is the CURRENT 800 lb. problem. The underlying problem is that the economic and monetary systems cannot be even relatively stable without adopting a cost free way to prevent the inevitable and understandable conventions of cost accounting from enforcing the build up of debt and hence periodic recessions and depressions. But I’m not interested in convincing anyone of that being so at this moment. All of the other things you mentioned, and what Steve Keen recognizes with the asset inflation would be resolvable after a citizen’s dividend and compensated retail discount were instituted. We need to make the economy and monetary systems work with those mechanisms as functioning realities. Computer software can make the credit flow in the needed ways and in the correct ratios to resolve the crisis. The dividend is to be spent on consumption, to pay off debt or to be saved. Saving is a cost of consumption and so in the formula of total cost of consumption over total cost of production it would lower the retail discount to consumers. The Distributive mechanisms of Social Credit are an evolution of fiat/credit based monetary and profit making systems. They empower people as individuals and they disempower elitist, dominating and corrupt entities. That is exactly what we need.
Steve H,
I am no expert on Social Credit (C H Douglas). It sounds to me like a utopian ideal that leaves out the basic problem of what I call human nature. I do not believe that laws can prevent greed or hubris. Maybe drugs could work? Mankind has survived and prospered IMO due to our survival instincts which includes very aggressive behavior. Government does have a responsibility in moderating and directing that behavior but so far that has only worked intermitenly. So far there has been no social order that has come close to what Douglas idealized as far as I know. So theorizing about something I do not believe possible > hasn’t taken up much of my time. Outside my early years reading science fiction.
As for defining whether our *crisis* is the outcome or consequences of our combined actions or the underlying issues is really just a matter of where you are viewing the crisis from. The combination of actions caused the undesired results. You seem to see the results as the crisis. Solving for your definition of crisis does nothing more than kick the can down the road and divert the consequence from one group to another. TBTF or pensioners would find that the repayment value is not adequate to fund the liabilities on their books. In many cases, these pensions or liabilities are guarantee by the taxpayers… thus the fix isn’t really a fix and the solution isn’t a save for the system.
Thus, just a game of musical chairs. And the fix depends on whether you have a guaranteed seat or not. In the Keen scenario, savers would be rewarded and extreme borrowers not. I am a saver so I would like this. The TBTF and pension and bond funds would not like it.
At this point, they have control and we don’t so other than theorizing, our best bet is to try and figure out how to nail our chairs to the deck.
Social Credit is not utopian because rather than forcing everyone into some particular vision of how they should act it actually frees individuals economically and monetarily from manipulation and domination by the same current tyrannical systems. Thus they have the time and the choice to create THEIR OWN SENSE OF FREEDOM AND IDEAL LIFESTYLE. That is an essential difference between totalitarian/utopian systems of whatever stripe which would force everyone into their unfree system. Economic and monetary freedom is an irresistible choice because you would either be wise to accept it or foolish not to. Choice is totalitarian. Freedom of choice to make one’s own utopian conception is itself NOT utopian.
Freedom and freedom of choice (self determinism) are the deepest and most basic of liberating experiences. That is what a Social Credit society would enable. Solving that current lack of such would allow all problems above it to resolve themselves, or be more easily resolved by Man.
Above should read “choice is NOT totalitarian.”
@Economicminor
You seem to recognize that economics is inseparable from politics, which puts you light years ahead of the economists, who labor under the fiction that somehow economics can exist apart from politics.
I thus find it surprising when you then turn around and state: “It would significantly reduce income to the Big Bad Bailout Banks plus throw a chaotic wrench into the pension funds throughout the country.” This statement implies that the pension funds (read workers) are equal partners with the Big Bad Bailout Banks in preserving the sanctity of capital.
Nothing, of course, could be farther from the truth. Labor has been politically evicerated over the past 40 years, and the effects upon the economic wellbeing of workers could not be more evident. If those with political power were to want to reduce the income of the Big Bad Bailout Banks and protect workers’ pensions, they could easily pass the necessary laws to make that an economic reality.
One has to look no further than the way capital is created to see the role political power plays in the capital creating process. For the workers, capital is created from the sweat of their brow, the product of work and matching contributions over a period of many decades. For the financial capitalists, capital is created instantaneously and effortlessly with the entry of a few digits oa computer screen.
One can also look at the way capital is destroyed. The capital of the finance capitalists is sacrosanct, and thus guaranteed by the government. That of the workers not so much so.
PBS did an outstanding documentary that explores the ease with which the capital of workers is destroyed by bankruptcy courts.
http://www.pbs.org/wgbh/pages/frontline/retirement/view/
It then explains how those same courts preserve the capital of the fiance capitalists.
There really is no substitute for having the judiciary, the legislature or the executive in your corner when it comes to matters of economics.
Glen,
Pension funds are run by the same people who run the banks and insurance companies of the world. All educated with the same doublethink economic theories. This allowed the banksters to dump/hide/sell trillions of *secured debt* to them (with very unrealistic returns). Cash to pay down debts will implode most pension funds because the imputed returns were a fraud, thus leaving many millions of retirees without income or with much reduced income.
You have to look at both who’s running what and what the consequences would be rather than just the ideological differences between them. Most people in the US are not happy about the banking fraud and bailouts yet have really nothing they can do about any of it. No difference with the workers and the pension funds. All have the same worthless regulatory oversight as the banks..
And yes the PTB could protect the special interests of the pensioners over the interests of those who have been left out of the economic pie but that is going down the same road we are on. Either we have free markets that are well regulated or we have crony capitalism or one of its brothers.
I know many pensioners who live better than when they worked. Much more disposable income. The math just doesn’t work out. Many had as much or more disposable income while the worked than almost all non union pension workers to start with, never saved, never had to and then ended up with far superior retirements than the majority of the workers in the country. Their incomes are based on unrealistic (fraudulent) accounting using the unrealistic returns of scammy securities. And you think their special status needs to be protected?
How will this mess ever get fixed if there are still special interests that are protected while the majority are asked for sacrifice?
As for the creation of this fictitious money to be passed around. It needs to be just printed or created out of thin air and NOT lent into existance otherwise it just becomes another transfer from future income to present consumption. We already have to much of that.
Steve and Glenn, thanks for the discussion. Doug Stohlman
if you want to continue, I will be on traveling all day it will be tonight PST or tomorrow for any reply.
Steve, even if Social Credit is a good idea doesn’t mean it is possible in a world of humans. Might work in a smaller community but I sure can’t see it working on a planet of how many billion?
Doug,
Happy to have the back and forth too.
Pensioners, whether they be CEOs or union leaders, who have exorbitant pay outs would/will have to console themselves that they are getting a REASONABLE pension plus their citizen’s dividend. That is considering BOTH their contributions AND the common Good. It’s the same principle behind declaring the quadrillion + dollars of derivative bets null and void and unwinding such so that there is basically no gain. Sanity and fairness must rule over insanity and privilege.
And again a cradle to grave citizen’s dividend will eliminate the larger need for pensions…and the associated taxes for social security as well as those for welfare in its various forms.
Social Credit doesn’t necessarily require a change in administration, but rather a change in policy. There is an iron law in both individual and systemic psychology. Whatever is one’s actual intent (and policy is only the legal form that intention takes) ….is what will tend to be. Currently the primary intentions of the competing economic theories of capitalism and socialism are:
Capitalism: Profit and the will to power of the system and its business and financial entities.
Socialism: Work and the will to power of the political elite which would administer it as well as their cronies.
Now, if you made the primary purpose and intention of the economic and monetary systems….the most efficient meeting of consumers with goods and services….you could include UNDER that primary purpose both profit AND work. And if you simply legislated a citizen’s dividend (which is really just the perfect policy expression of both grace and individual freedom) you’d actually put individuals in control of economic policy….which resolves the current two competing theories’ problems with the will to power of their system by replacing it with the will to freedom for the individual.
Everything begins and ends with philosophy i.e. the ideas, values and experiences a philosophy intends and so tends to enable. So much more important that we base and intend our systems on the best possible ideas, values and experiences.
The present systems are based on mistrust, tend to create hopelessness, a lack of affinity for one’s fellow and so make for a mentality obsessed with exchange i.e. “only this for that”. “There are no free lunches” as so many libertarians tend to intone.
Human nature is really a rather malleable thing, and we should guard against thinking it is some specific entity, particularly an entity which is largely molded by culture. We can say Man is flawed. That is fine. But to say he is necessarily only competitive, aggressive, lazy, irresponsible etc. etc. is a stretch that smacks of being culturally hidebound. The following quote from C. H. Douglas sums up my thoughts on systems and their best and correct intentions very well:
“Systems were made for men, and not men for systems, and the interest of man which is self-development, is above all systems, whether theological, political or economic.”
@Economicminor at 2:49 am
Your entire lament seems to boil down to the fact that governments, and especially the federal government, have proven to be superior counterparties to anything the private sector has to offer.
The pensions of private sector workers weren’t always this vulnerable to the vagaries of the private sector. Jacob S. Hacker calls it “The Great Risk Shift.”
As Hacker explains in his book by that same name, in the U.S. the Pension Benefit Guaranty Corporation guarantees traditional defined-benefit pensions. For companies that offer traditional defined-benefit pension plans, like United Airlines, nine out of ten employees get the benefits they were promised. The exceptions are highly paid workers and those who did not reach the age of sixty-five before benefits are paid.
Most US workers’ pensions, however, are now exposed to infinitely more risk. The reason? Defined-contribution plans, like 401(k)s, are completely uninsured, and
It was Reagan, backed by Wall Street and right-wing think tanks like the Heritage Foundation and the Cato Institute, who ushered in this revolutionary change. And for right-wing conservatives, defined-contribution plans are like the gift that keeps on giving:
1) They are not insured by the Federal Governemnt
2) They are dirt cheap. In the late 1970s, employers devoted more than 4 percent of workers payrolls to pensions. By the late 1980s, they were contributing around 2.5%.
3) They are a boon for mutual funds and investment banks, who, Hacker observes, “embraced 401(k)s as the Second Coming.”
4) And finally,
All this revolutionary change has of course proved to be disastrous for American workers. Unions knew this, but were unable to hold back the tide. As Hacker goes on to explain:
What we saw during the GFC was that at the same time pension funds got murdered, the financial capitalists got thown a life line. And this happened whether explicit Federal government guarantees existed or not. Besides the $700 billion in TARP funds, there was another $7.77 trillion that the Fed secretly loaned banks around the world against their toxic waste at almost 0% interest rates, $1.2 trillion to US banks (this was at the highest day on December 5, 2008). All this was done to keep the banks “solvent” and “liquid” and to provide them with a way to “earn” their way back to balance sheet sanity.
This begs the question as to whether a banking system dependent for its survival upon secret loans from a democratic government is in a defensible position.
A cradle to grave dividend based on the value of the technological progress of the nation, the value of which is communally owned but currently totally usurped by the Banking and monetary systems is the answer to pensions, retirement and even the unemployment “problem” itself.
Capitalists are going to have to confront the absurdity of its internal logic sometime. What?, are we going to wait until only 5% of us are merely button pushers earning an income and have the nations production shut up behind gates guarded by gun toting security?
Likewise socialist/labor thinkers are going to have to think the same way about work. namely that it is going to become less and less necessary. Forget about “making work”. Thats just another enforced usage of everyone’s time and effort in the end. Let people have the demand they want and need, get extra for their jobs if and while they have one….and otherwise let us freely choose what to do with our time.
If I may, to expound upon the value of technological progress itself, and its potential uses.
The Banking system is severely restricted in its ability to lend in an area/nation where there has been no technological progress, no cultural heritage of productive capacity built up over time. Currently, in nations that ARE developed the Banking system usurps ALL of this valuable factor of production/ability to LEND into and so derive profit from, even though it is a communally created potential and resource. A citizen’s dividend redresses this imbalance and has the advantage of insuring adequate demand in the hands of individuals in perpetuity so that businesses of all kinds including Banking are made more stably profitable. It should also in fact make for overall lower interest rates due to increased creditability of both individuals and businesses.
If private/consumer debt is the biggest current problem then a citizen’s dividend is its most rational and equitable solution.
Technological progress is cumulative and except for the effects of war imperishable. There is no need to “reinvent the wheel” in every financial cycle and so this asset can be monetized and distributed continually. The monetary system being creditary in nature, the credit distributed as the dividend and directed mostly toward consumption or retirement of debt would cancel each other out. Most savings by the vast majority of individuals would be utilized to purchase/pay off loans much more quickly for big ticket items such as cars, appliances etc. and so neither excess savings nor private indebtedness would tend to accumulate.
It is way past time that economists and the public at large woke up to the reality of the value of technological progress and the current unbalanced distribution of such.
I suppose it would have helped if I’d started with the right equations. In the Goodwin model, u is the wage share of output, ie. the pool of honestly earned money. 1-u is the profit share, or the demand for investment. So, (1-u)/u = r is the real interest rate ie. the price of borrowed money.
With endogenous credit, in addition to the wage share there is the debt service share d, which is, of course, paid by the wage earner. So, the nominal interest rate is i = (1-u)/(u-d). The curves below show i as a function of u for various levels of d =(0, .05, .1, and .15) with d = 0 being the real interest rate (bottom curve)
The inflation rate is simply i – r . The curves for d =(.05, .1, and .15) are shown below.
Thus, with 2 independent variables, u and d, one can calculate the dependent variables r and i and explain the whole cockamamie GFC on the back of an envelope to an uninterested person who couldn’t care less about it.