Friday, July 27, 2012

Cato Goes Money Crank

It's hard to think about this any other way, other than monetary crank stuff, given the series of columns that have been written by Steve Hanke and published at Cato . Hanke is calling for money supply increases and a bizzare method to create the new money. He is using Cato to advance his view and as an outlet to rebut his critics.

Here's how Hanke  suggests the money be created:
While there are many debt-operation possibilities, we will limit our discussion to one that would directly boost the money supply, without increasing the government's net debt. The process begins with the government borrowing from commercial banks. Short-dated government paper is transferred to banks. In exchange, the deposit balance of the government is credited.
This new government deposit is not counted as a part of the money supply. The government then uses its bank deposits (which are not considered money) to purchase long-dated government bonds from the non-bank private sector. These transactions add to the non-bank private sector's bank deposits and directly to the money supply, because bank deposits in the name of private persons and entities are money. So, the quantity of money is directly increased by this debt market operation and an equivalent amount of long-dated government debt is reduced — literally eliminated. (Since there is little point in the government holding claims on itself, the government cancels the claims.)
Of course, the amount of short-dated government debt increases when the government initially borrows from the commercial banks. Accordingly, the debt market operation leaves the government's total net debt unchanged, but it does change the composition of the government's debt, leaving it with a shorter average duration.
Debt market operations — like the one described — would directly increase the money supply, contain the crisis, and allow for much-needed market-friendly reforms.

Oddity 1: Hanke says, " This new government deposit is not counted as a part of the money supply" Why not? The government has a new balance at a bank. Why can't it be used to buy any type of goods it wants? So the money is created at this point, but only if the banks were going to otherwise keep the funds as excess reserves, otherwise they would have been lent out to others instead of the government, so this operation in itself does not mean that money is created here that wouldn't have been created by the banks loaning the funds in some other sector. But note well, under either scenario, the Federal Reserve is ultimately controlling the money supply because it controls the amount of reserves, which it can add to or drain at any time.

Hanke is, thus, mistaken that the government, under the current Federal Reserve system, can go in and directly borrow any amount from the banks. Reserves must back up any bank loaning (on a fractional basis) and those reserves are created and controlled by the Fed.

Oddity 2: Why is Hanke proposing an initial increase in short-term debt and then a retirement of long term debt? This is making the government even more vulnerable to short-term interest rate fluctuations? In his bizarre model he could just as easily have started out with the issuance of long-term debt and the then buying up of short-term debt, which would have made the governments balance sheet much more stable.

Indeed, he seems confused about Operation Twist::
....all debt market operations of the type I am envisioning, long-dated debt is replaced with short-dated debt (and so, in one sense, there would be some similarity with Operation Twist).

The Fed's Operation Twist is resulting in the Fed purchasing long Treasury securities and selling short term securities, thus providing the opportunity for Treasury to extend the maturity of the Treasury balance sheet---the exact opposite of what would occur under Hanke's program.

Hanke further fails to understand that as part of the Fed's Operation Twist, when the Fed buys long-term debt, it is sterilizing its operations by selling Treasury securities of shorter maturities. This gives the Treasury the opportunity to extend the maturity of its debt securities without adding to its debt balance sheet, by buying in the short-term market at the same time the Fed is selling there , and by issuing longer term debt, where the Fed is buying. And, indeed, this is exactly what the Fed is doing.

Thus, Hanke is completely wrong when he writes:
The central bank could engage directly in debt market operations (and several have done so in recent QE operations). But, in this case, the long-dated bonds purchased by the central bank would end up on the central bank’s balance sheet. The debt would not be canceled out, as it would be if the government was to conduct debt market operations.
This is wrong. If it is sterilized the way the Fed is doing, it can cancel out both on the Fed's balance sheet (leaving just long debt), and also (removing short term paper) on the Treasury balance sheet. Hanke is simply very confused.

That such nonsense has found its way onto the pages of Cato suggests how far Cato has deteriorated. And I am not even going into Hanke's major Chicago school/Keynesian premise that printing money somehow boosts the economy in anything other than a manipulated distorted manner.



  1. Isn't that sort of what Ellen Brown was asking for?

    So you're switching long-term bonds held by private non-bank parties for money. That's the same plan as hers.

    The purchase comes from short-term borrowing by the government from commercial banks.

    That doesn't add to the money-supply in the sense that being short-term the loans doesn't generate new loans.

    Am I understanding this right? Or am I confused?

    But it sounds exactly like Ellen.
    It might do what he says, you know.... but likely it's about arbitraging the interest rates in some way.

    Note to self:
    Stay away from all banks.

    Keep money in sock, or exchange/barter work credits.

  2. Oops/
    Should be "the loans don't"
    Sorry. I never re-read before posting.

  3. Look. Nothing up my sleeves, nothing in my pockets, absolutely nothing between my ears. Now I just reach into the magic hat and pull out a... OH CRAP!!!

    This bunch would do better by tackling something more in their league like moving a pea around on a card table with some walnut shells.

    The worst thing that can ever happen to a man is that he begins to believe his own bullshit - case in point.