Wednesday, 2 January 2013

When governments become banks

The Bank of International Settlements has produced a paper discussing the global shortage of safe assets and suggesting a solution. It's a fascinating paper, not least because of the glimpse it affords into the looking-glass world of finance. I've noted before that to the financial world, the real economy is simply a source of resources to support financial trading and investment. If the BIS paper is anything to go by, so are governments.

The background to this is the catastrophic failure of supposedly "safe" assets twice in the last five years - first residential mortgage-backed securities (RMBS) in the financial crisis of 2007-8, then Eurozone sovereign debt. Gary Gorton, in response to the failure of private sector "safe" assets, remarked that only governments can create "safe" assets. But not all governments can. The Eurozone crisis shows us that those that don't issue their own currency, those that are perceived by markets as being profligate, and those that are suffering severe political or economic stresses - none of these can produce "safe" assets. There is a diminishing number of countries that can produce assets that are reliably regarded as "safe", while global demand for safe assets is skyrocketing due to increased regulatory requirements for financial institutions, shortening collateral chains in shadow banking, and investor risk aversion.

There have been numerous attempts to explain the declining yields on US, UK and Japanese debt, since in all three of these the debt/GDP ratio is considerable and rising, which should force their yields up. Pessimistic commentors have been warning for years that these debt assets are overvalued and collapse is imminent, but there is still no sign of this. The US downgrade is now a year old and yet US Treasuries are trading at the lowest yields in history. The UK faces probable downgrade in the spring, but the markets don't seem to care. And the most inexplicable of the lot is Japan, which has the highest debt/GDP ratio in the world but pays the lowest borrowing costs. Markets really don't seem that bothered about high debt/GDP ratios in these countries. It seems grossly unfair that a country such as Italy, which in economic fundamentals is rather similar to the UK, pays much more to borrow. But the difference is that Italy has no central bank. Yes, I know it has something CALLED a central bank - but it is part of the Eurosystem and subject to the ECB's rules. It cannot issue currency except with the ECB's permission and has no control of monetary policy.

The BIS paper makes it very clear that a country that has no central bank, does not issue its own currency and has no control of monetary policy cannot create "safe" assets - although it seems to make an exception for Germany, probably because its dominance in the Eurozone means that effectively it runs the place. The crucial determinant of markets' attitude to debt is the existence of a credible monetary backstop. BIS recommends that central banks should act as investor of last resort for their own countries' debt - monetizing freely on demand. This is not to shore up government finances (I shall return to this in a minute), nor to adjust monetary policy. No, it is to instil confidence in the debt. If investors know that the central bank will always exchange government debt for money, they can regard that debt as 100% safe.

Well, almost. There is of course currency risk. The central bank may be able to buy unlimited amounts of debt, but if the currency is under pressure then the value of that backstop is eroded and the debt cannot be regarded as 100% safe. So the other side of this is the critical importance of inflation control to protect the currency. All central banks currently target inflation, although they also have a secondary responsibility to ensure financial stability and the Fed's "dual mandate" targets full employment as well as inflation. But there have been calls for central banks' inflation targets to be raised, eliminated or replaced. This is anathema if the purpose of government debt is to provide safe assets. Inflation erodes the value of both the debt and the currency: it is effectively taxation of safe assets. In a high inflation economy (by "high" I don't mean 3% or so - I mean heading for double digits) government debt is not a safe asset. In fact in a high inflation economy there can be NO safe assets other than physical ones (such as gold). Hence the emphasis on inflation control. Investors don't give a stuff about unemployment unless it becomes high enough to threaten political stability, which itself puts safe assets at risk. But maintaining the value of safe assets is crucial. Safe assets CANNOT EVER BECOME UNSAFE - or they are not safe assets. As BIS puts it:
"It is of the essence of a safe asset that it should not become unsafe."
Therefore, governments whose debt is regarded as a safe asset must operate monetary and fiscal policy in such a way that their debt retains its value. They cannot allow inflation to rise significantly, and they must maintain control of public spending to ensure that they can always meet their liabilities when they fall due. The very existence of safe assets relies on the soundness of sovereign monetary and fiscal policy.

From a national economic perspective, this looks completely ridiculous. On the one hand, government must produce unlimited amounts of debt to meet the financial system's demand for safe assets, and allow the central bank to exchange this debt freely for new money. But on the other hand, they must maintain strict control of inflation and government spending so that the safe assets they are producing remain safe. So the debt/GDP level can rise to the skies, though they will pay nothing much for it: in fact debt/GDP would become a completely meaningless measure of the soundness of public finances. But woe betide any government that ran a deficit. The BIS paper envisages governments running primary surpluses to fund debt issuance:
....each major economy could ensure the safety of their domestically-issued public debt instruments through sound fiscal policy (ensuring that the present value of future real primary surpluses is sufficient to cover outstanding real liabilities in most states of the world)....
It is an extraordinary reversal of the way we normally think of government finances. But I did say the financial system is a looking-glass world. In the financial world, the purpose of government debt is not to fund government spending. It is to provide safe assets.

The BIS proposal for ensuring the supply of global safe assets in effect treats currency-issuing governments - especially the US - as the world's savings banks. We can regard this proposal as a form of full reserve banking: government provides a safe deposit facility for investors, borrowing large amounts of money but putting it safely in a vault so there is no possibility of not being able to return it. This is not simply an analogy: producing debt in excess of spending needs will mean that governments become cash-rich, and if governments are running primary surpluses as well then they will be awash with surplus funds which they dare not release into the economy for fear of triggering inflation and a run on their supposedly safe assets. They will inevitably place these funds on deposit at their central banks, which amounts to putting them in a vault. Meanwhile - BIS assumes - these governments will continue to maintain strict control of public spending. Quite how the public would respond to a government that was borrowing heavily and placing excess funds on deposit at the central bank while holding down investment in the real economy would be interesting. Sometimes I think bankers forget that governments are elected by real people, who don't give a stuff about safe assets when they are facing unemployment.....

However, there is one very important point to the BIS proposal. It eliminates once and for all the idea that monetizing public debt inevitably leads to hyperinflation. The BIS model shows that monetizing debt can be done at at little risk of inflation. And for BIS, sovereign default is a disaster, because it destroys safe assets and risks the stability of the financial system. That reason alone is sufficient to justify debt monetization, given central banks' responsibility for financial stability. The IMF, the EU and - especially - the Bundesbank should take note. Better to load the central bank up to the skies with its own government's debt than risk a catastrophic sovereign default and global financial system meltdown.

And the other thing to note is this. In the BIS model, each currency-issuing nation has a public savings bank - government - and a public fractional reserve lending bank - the central bank. The fractional reserve lending bank acts as lender of last resort for the savings bank - hence debt monetization. And it is itself backed by government, because as a last resort government would use tax income to recapitalise the central bank. There are two massive assumptions underlying this: firstly, that central bank insolvency is never an issue because it can always meet its liabilities by creating money, and secondly, that populations can always be taxed sufficiently to meet all government liabilities including (if necessary) central bank recapitalisation. I don't propose to discuss either here, though I have serious reservations in particular about unlimited taxation: people can only be taxed to the extent that they are willing and able to pay that tax. And the whole thing looks dangerously circular to me. I can't help feeling that if the world is really so dependent on safe assets remaining safe, there may be a need for a supra-national monetary backstop.

Actually BIS does note that there may be a need for a global monetary backstop for safe assets, not because of central bank or government insolvency but because of competition between different safe assets setting up arbitrage loops and creating destabilising volatility in the financial system. Yet another role for the IMF, it seems. Which means that it would have to become a fractional reserve lending bank in its own right. Welcome to the new World Central Bank.

Or perhaps, more accurately, welcome to the World Central Government. For if governments are banks, and are backstopped by banks, and exist primarily to serve banks and investors, then who is it who really runs this show?


  1. Erm, so I need to tell my kids that the purpose of governments is to create safe assets, which are THE MOST IMPORTANT THING EVER? That ought to be funny.

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  2. We are at the start of a major currency collapse,the financial crisis of 2008 was just the beginning

  3. What would happen though, if people stopped borrowing, spending in excess of their inflows, stopped creating as much debt? Would that not inhibit/hinder the vicious cycle?

    1. It would make absolutely no difference. This isn't about private debt - it's about public debt morphing into an asset that is so important to financial stability that governments must organise their monetary and fiscal policies around supporting it. In fact as people rely on public debt as a safe home for long-term savings, the more savings they have the greater the need for public debt.

    2. Right, but isn't it private debt that is being leveraged and monetized? Isn't that the point of origin? I mean, if there was no private debt to begin with...

      Sorry if this is posted twice!

    3. Bill Mitchell in his MMT blog:

      explains succinctly the relationship between sovereign debt and
      private savings, which I will paraphrase as follows:
      "the sovereign must issue debt to meet the demand of the private sector for a safe vehicle in which to keep their savings. All currency in a fiat currency regime is spent into existence by the sovereign governmental issuer, and is removed from circulation through taxes. Currency in excess of that needed immediately is stored through the medium of sovereign debt into which it is "invested". For this to happen the sovereign must create sufficient sovereign debt to meet the demand for it."


    4. Yes, that is very close to the BIS attitude to sovereign debt. But I know from Mitchell's work that he wouldn't be in sympathy with BIS's attitude to fiscal policy. Nor am I, actually. They think governments should run primary surpluses - so routinely extract more currency from the private sector than they put in. That is only compatible with sovereign debt issuance if the debt is bought by non-residents - which implies that much of the issued currency must go abroad, presumably through running a substantial trade deficit.

      The macroeconomic stance of this paper is nonsensical from a purely national perspective. It only works if taxation is national but the debt assets global. And it would result in persistent deflation and growing private sector indebtedness for the issuing nation unless it also ran an external surplus - which obviously it can't do if it has to run an external deficit so that the currency can go abroad and be returned through debt purchase. Actually this is pretty much what happened to the US in the Bretton Woods era. It wouldn't be sustainable.

  4. Right, but isn't it private debt that is being leveraged and monetized? Isn't that the point of origin? I mean, if there was no private debt to begin with...

    1. No, this is about PUBLIC debt. To pay for public spending, originally. Nothing to do with private debt, necessarily.

    2. I'm getting you... but then, if govts (US govt) are inclined toward austerity (assuming it is overall spending cuts and not just for SS, Medicare and programs that actually benefit the populace), this inclination would run contra to the fin. sector's goals. So we would then have to assume that the austerity is going to exclude spending which benefits 'big' business (military, privatized public education, etc.).

    3. Exactly - now you're getting it! That's why the BIS proposal is so poisonous. It institutionalises the diversion of government away from the care of its own citizens towards serving the needs of the financial sector.

    4. You are right...your title does not *begin* to describe the insidiousness of this proposal. Thanks for being patient and taking the time to clarify. The trend literally keeps me awake at night and I despair at the extreme lack of understanding amongst many of the Dem. party activists with whom I used to 'hang out'.

  5. This is all madness. The world financial system is in a mess precisely because people believe that there is such a thing as a safe asset. There is always risk in any investment this is because for every buyer there is a seller and for every winner there is a loser. If governments just print money to cover losses then we will be in a utopian dream where there are no losers. The world financial crisis is ongoing, it has not been solved and the current developments are only propping up a failed structure. The collapse is inevitable.

    1. Avoiding losses is exactly what this is all about, Richard. I have serious reservations about the whole thing, actually. I think expecting governments to create and maintain risk-free assets is unbelievably dangerous for the real economies of those countries. Investors need to get real. There is no such thing as a risk-free asset - as I discussed here:

  6. Hi Frances,

    BIS so called “economists” are nearly a century behind the times. The idea that government & central bank should produce safe assets is just a variation on Keynes’s paradox of thrift point: that is that if the private sector does not get the paper assets it wants (i.e. money and/or government debt) the private sector will save, which in turn will cause excess unemployment.

    Moreover advocates of Modern Monetary Theory have been saying the same thing for years, except that they use the phrase “private sector net financial assets” instead of the phrase I used above, namely “money and/or government debt”.

    Re your claim that having government supply the private sector with the paper assets it wants equals full reserve banking, I don’t agree. Having government do the above is perfectly compatible with our current banking system, i.e. fractional reserve.

    1. If the government provided a 100% safe deposit facility for private savings, fully backed by reserves at the central bank, then it would effectively become a full reserve savings bank. That is what the BIS proposal amounts to. The fact that the government produces tradeable certificates of deposit (which is what gilts are, really) wouldn't change the underlying setup under this proposal. Nor would it in any way affect the current banking system, which would remain a fractional reserve system.

    2. Fair point. I jumped to the conclusion you were saying that the ENTIRE banking system becomes full reserve just because people treat government as a savings bank.

  7. genauer says:

    Just close the BIS down, this year. There are no German reparations to distribute anymore. The bureaucracy is completely useless and dangerous.

  8. It's NOT a BIS proposal.

    1. It's a working paper from the Bank of International Settlements, usually known as BIS. I agree calling it a proposal may be premature.

    2. The paper was presented at a conference organised by the BIS. It is written by two academics and is one of the conference papers. This is clearly stated.

    3. Thank you. In that case I think it is fair to call it a proposal.

    4. But not by the BIS. By the two academics.

  9. Issuing your own money is not in and of itself a good thing, obviously! In fact, that ability correlates quite closely to producing chaos. Just imagine if each citizen or local council could issue their own currency. Hardly desirable! It's not clear to me that local politicians can just 'create' so called safe assets? Governments do not generate income, remember, they just tax people, and their is a limit to what society will accept.

    Anyway, the UK is already closer to Soviet Russia than to unconstrained capitalism, so it is about time these things are properly planned centrally.

    Unfortunately, the world government has never been weaker.

    1. I'm very puzzled by your comment. I have not suggested local currencies, or local politicians creating safe assets. The sovereign nations US, UK, Japan (among others) currently issue their own currencies and their own debt assets, which are widely regarded as "safe". Do you have a problem with that?

      Also, what do you mean by "the world government has never been weaker"? There is no world government and never has been. But the implications of this paper from BIS would take us closer to having a world government than at any time since the collapse of the British Empire.

    2. "Governments do not generate income, remember, they just tax people, and their is a limit to what society will accept. "

      Government spending is private sector income. Macroeconomics rule #1. All private sector financial wealth comes from the government.

      As Frances noted, "national debt" is private sector financial wealth. And pretty much netts to the dollar.

    3. Detlev Shitler is a clueless shiny-metal fetishist.

    4. "All private sector financial wealth comes from the government".

      "Net financial assets" maybe, but not "all financial wealth"

      Gold buggeristas like Detlev Shitler are the religious nuts of our time, always proclaiming that "the end is nigh", that "we must repent for our sins", and that "the world is in the thrall of satan (government)".

      Repent! Repent!

      It's funny that gold was historically important in religious rituals and was believed to have divine powers.

  10. It is intricately difficult to distinguish money creation from either the public or private sector. Money serves a public function, yet the private sector can also create money (and thus, safe asset collateral).

    As we seem to agree, the failure of the rating agencies to properly qualify "high-quality" MBS led to a destruction of PRIVATE money (and thus, safe asset collateral) that was without precedent. In other words, the majority of safe assets prior to the crisis were considered non-government in nature.

    Currently, the Government is simply trying to fill a role that is too big for its shoes (i.e., it cannot create the amount of safe assets to the same extent MBS were created by the private sector). As you state, this helps explain why yields for the U.S., Japan, and Germany are so low. The demand outstrips the supply (by a wide margin).

    Nevertheless, my question to you is: don't you think it is simply inevitable that the PRIVATE sector will ultimately create safe assets. Or (perhaps) simply *change* the definition of safe assets? Or do you believe that the private sector will be unable to create safe assets or "re-value" the definition of safe assets? As in, do you think it is unlikely (given the financial crisis) that the private sector would consider anything except GOVERNMENT debt to be considered a "safe asset" for decades to come?

    1. I don't think there is any such thing as a safe asset. And I don't think it is the proper function of governments to devote public resources to backstopping investors who want to believe in the myth of safety. The propensity to hoard instead of invest in productive activity is immensely destructive. The last thing we should be doing is encouraging it. Therefore I think the BIS paper is fundamentally flawed and its proposals potentially disastrous for the global economy.

      FWIW, I think that the private sector will not be able to create anything remotely "safe" for a long time to come. But that doesn't mean that governments should do so. As I said in an earlier comment, investors should get real and accept that risk is part of life.

      I have written about this before, which is why I didn't spell out my objections to the whole concept of "safe" assets in this post. My earlier post on the illusion of safety is here:

    2. the idler of march4 January 2013 at 08:12

      This is a great post, but I'm not sure if I understand the ethical issues with generating safe assets in order to keep the financial system supplied. It certainly is possible to tabloid this up a bit and make this sound like a bad thing ('print money to keep bankers happy' or something), but maintaining a functional financial system (with associated transfer of credit to the private sector) is something on which the economy and consequently the wealth & happiness of the populace at large depends. I think it is also a false choice to suggest that more safe assets = less risky lending and more unproductive money hoarding. If these safe assets are used as collateral by the financial system then this tends to lead to an increase in credit & investment in the wider economy. Certainly the reverse is true - a sudden contraction of safe assets also causes a contraction in risky lending, and not a substitution into risky lending. Safe asset demand is not necessarily encouraged by a greater supply of safe assets - risk-averse lenders can always move into cash-like assets, whether there are government bonds available or not.

    3. If you read my comment to Dr. George above, that summarises the ethical problems. It's not the creation of safe assets itself, it's the economic stance that BIS considers necessary to keep them safe. In particular, the need for primary surpluses even when large amounts of debt is being issued. This would impoverish the local population while benefiting foreign investors. It amounts to governments putting the needs of the global financial system for safe assets ahead of the welfare of their own citizens. That is why it is poisonous. For government debt to be both unlimited and safe the issuing governments must run fiscal DEFICITS, not surpluses - but investors don't understand this (and most economists don't seem to, either).

      In a normally-functioning financial system, a plentiful supply of genuinely safe assets does support risk investment. But we don't have a normally-functioning financial system. We have a damaged and highly risk-averse one. And in such a system, a plentiful and cheap supply of risk-free assets would actually discourage risk investment. When the private sector's propensity is to hoard - which is the present situation - risk-free assets need to be scarce and expensive. This proposal does nothing to make them so.

  11. To read the BIS paper is to discard it. Every paragraph contains some silly/disagreeable point.

    "Safe assets are a cornerstone of modern financial systems. They provide a reliable store of value, serve as collateral in financial transactions, fulfill prudential requirements, and serve as a pricing benchmarks."

    The BIS undermines its own argument by offering it: there is (ongoing) finance system instability therefore there are no risk-free assets, the one is evidence of the other.

    A risk-free asset is one that needs no defense by central banks. The central banks are buying all assets including government securities. What does this say about the debt instruments, that the central bank is compelled to buy them?

    The central banks are creating trillion$ in excess reserves. How secure are deposits in banking system if the central banks must provide + $1 trillion per year against them? Is there something about deposits that we should know about?

    The governments are not 'savings institutions', they are a component of the funds transmission system from the central bank(s) to the commercial lenders/tycoons. Government debt is nothing but trash paper subject to blatant manipulation. That is why yields for official paper are low: how much would lenders charge the Treasury if it had to borrow from them without the Fed making the automatic bid?

    The BIS article is nothing more than propaganda for sanctified money, 'Holy Money' that is elevated above all things. Currency is, after all, the ultimate risk-free asset ... right?

    The BIS and the central banks have run aground on the Paradox of Thrift: their problems scale while their (putative) solutions cannot.

    The system's empty promises are just that ... all of the BIS's horses and men cannot change that perception.

  12. In an economy with advanced technology, do we tend to have more savings than we have investments with positive returns in which to invest? And the more lopsided the income distribution the harder it becomes since the wealthy savers find few safe investments among the poor.

    We tend to confuse saving which becomes an investment with saving which is simply hoarding. Instinctively we want to hoard to get through the long winter. But today hoarding just reduces economic activity and leads to destructive speculation. Therefore I think the pay as you go Social Security type of retirement funding makes sense because it alleviates the need for saving - it directly distributes money from the young to the old. But that is an anathema to our hoarding instincts.

    If the government needs to create more safe assets, it can do so by guaranteeing some private investments, such as is done in mortgages, student loans, small business lending, and alternative energy. Of course politicians can become captive to the private interests that are guaranteed and malinvest, and bureaucrats can be poor risk managers. The government sometimes screws up royally in guaranteeing safe assets, but they generally do a good job. I like it better than the government borrowing money and paying interest for the heck of it.

    1. I like the direction of your thinking. Two points:

      1) demographic changes can make pay-as-you-go schemes a terrible burden on the young. And as the elderly tend to be asset-rich and the young asset-poor, if the young are to be taxed on their incomes to support the elderly, the elderly arguably should be taxed on their assets.

      2) Government guarantees for private sector assets blur the distinction between private and public sector. It is stealth nationalisation, really.

    2. I agree that pay as you go must adjust premium and benefits for demographic changes - so be it. But I don't think we have to tax the elderly's assets merely because of their age. Though the elderly do tend to consume more real estate than they don't use - so tax the land as Martin Wolf has suggested. And lay a big estate tax on anything over say 10 times the median annual income, because after all the kids didn't earn the money.

      Regarding stealth nationalization. I see your point, though I think we've come to assume that the public sector must be bad. But credit risk taking, particularly on mortgages, is all about taking the economic tail risk, and only a fiat government can take that risk. We can hide the risk behind federally insured banks, or be explicit about it. But any catastrophic risk will ultimately be the government's. If we are explicit then maybe the government will be compensated for the risk.

      Even for risk that isn't catastrophic, if the risk is mandatory participation then I'm not sure what benefit the private sector adds over public sector administration. Health insurance or car insurance are just diversifying risk without a tail, and they get to re-price risk every year. Could the government provide better insurance by eliminating the 10% profit margin and reduce the 10% operating expenses built into premiums?

      I'm not a heretic, I just sound like one.

    3. I don't mean a specific tax on assets held by the elderly. I mean a tax on assets such as real estate that are mainly owned by the elderly (because younger people's real estate holdings are nearly all mortgaged). Wolf's land tax would do the job, or some kind of property tax. And I don't have a problem with estate tax either (we call it inheritance tax here in the UK). As you say, it's unearned income.

      I don't have a problem with nationalisation if it is explicit. I don't like stealth nationalisation by government guarantee, because everyone always acts so shocked when that guarantee is called upon. If taxpayers are on the hook they need to know they are.

  13. Looking at the physical world or the black hole as you accurately called it in a previous article - your observations strike a chord.

    Spains capital flight moves north - crossing the Pyrenees
    Lets say French based banks benefit.
    Banks make money via arbitrage - the utility of the asset is not important to them - they just wish to capture the cash / fossil fuel flow held within the asset , essentially farm the fiat itself.

    They are now quite ironically creating more Spains in North Africa & Turkey while they can't afford to maintain the present built assets in Spain, Italy & Greece.
    Absurd but true
    For example there is a functional Tram in Jaen Spain since may 2011 and it is still not operational simply because of a lack of tokens.....
    The tokens must chase yield elsewhere.
    Why is this ?
    Because I imagine if they give people more equity (greenback) like claims on the country the banks claims dilute.
    So they must always seek to waste more resources on "growth" (outside of Europe) to put off that evil day and thus maintain their leverage power
    The one problem is that their precious machines (machines replace labour) input costs just keeps on rising - they must chuck more people off the European cliff, this is why domestic demand keeps on falling in the eurozone.

    This video explains a lot.

    They must destroy Spain to create more post 1986 Spains.....

    Its beyond sick.

  14. In fairness to the BIS authors, I don't see anything in their post that warrants your assault. They are not advocating govts issuing debt only to hoard funds at their CBs. What they do outline (almost as a footnote) is one possible (eventual?) route by which govts could anchor the 'safeness' of their debts (by running sound public finances). But the reference to the PV of future budget surpluses having to be demonstrably adequate to cover public debt in order to earn this external credibility is merely restating a fairly orthodox position; it in no way implies that these authors expect large debt-issuing govts to run continuous surpluses (which would be rather absurd, justifying your indignation). What they are saying is that govts pursuing this route need to be able to persuade the market that they could generate surpluses eventually.

    The paper is a (characteristically recondite) call for govts with the luxury of a captive CB to ensure their CBs provide a 'monetary backstop' - ie a promise to underwrite government paper. They suggest that this not only reduces the risk of default, but that it need not achieve this at the expense of an offsetting risk of inflation.

    While their prescription is eventually underwhelming and conservative ('more of the same, please'), the emphasis on the importance of low-risk assets is well-placed. The observation that the public sector has to play a role is also astute. I have written on this issue in the context of Italy (, and also offered much more comprehensive alternative social contract (http://www.scribd....A-Wealth-of-Labour)

    1. It may be a fairly orthodox position but it would actually be impossible to achieve unless the demand for safe assets were to decline, allowing the government to exit from the safe asset production line. While the government is locked into producing safe assets on demand for the global marketplace it cannot possibly run a primary surplus without indebting and impoverishing its population. And there is no suggestion in the BIS paper that the need for global safe assets would decline any time soon. Given this, please tell me how a government that was contributing to the global need for safe assets could "persuade the market" that it could run primary surpluses at some undefined time in the future?

      I have not argued with the BIS model that showed monetization of debt could be done with little risk of inflation. On the contrary, I think my post makes it clear that I consider this an extremely useful contribution. Nor have I argued with the suggestion that CBs should routinely provide a monetary backstop for sovereign debt. My criticisms of the paper rest on the unresolved tension between local and global needs - a form of the Triffin dilemma.

  15. I simply wish to caution against reading excessively into their reference to future primary surpluses. It does not make an appearance until late on in their paper, and I don't believe that they necessarily subscribe to the view.

    If one accepts that government bonds are bought on the basis that the investment will be returned in real terms - and given demand for safe assets is certainly constrained at some share of GDP - then you will agree that government issuers cannot run primary budget deficits indefinitely. If the initial premise holds, I would agree with you that their analysis, since it concludes by limiting issuers of safe assets to only a few governments, would come unstuck on a global stage.

    However, I am not sure the authors accept the premise that bond investors need to believe they will recoup their real investment: after all, the utility of the monetary backstop is based on its nominal flexibility in a world of few alternatives. They are endorsing financial repression, which I view as a dismal ambition.

    I have outlined my views at

    1. I beg to differ.

      A constant theme throughout this paper is the need to ensure that "safe" assets really are safe. The central banks' monetary backstop is of course key to this - but it is not enough. Unless there is also a commitment by government to ensuring the safety of these assets, they cannot be regarded as safe - and they will not be. The orthodox economic view is that sound fiscal and monetary policies are required for government debt to be regarded as "safe". And orthodox economics at the moment regards deficits as bad, to be avoided and to be eliminated as soon as possible. "Good practice" is balanced budgets or, ideally, primary surpluses. Hence the IMF's remark, in their recent explanatory article about fiscal multipliers, that virtually every major economy needs to embark on a path of fiscal consolidation.

      This in my view is the heart of the matter. Orthodox economics and the BIS view of government debt are fundamentally in conflict.

      Government policies aimed at ensuring that assets remain safe - eliminating not only default risk but inflation and refinancing (duration) risk - are bound to come into conflict with the needs not only of the domestic economy, but of the financial system as a whole. The financial system needs a plentiful supply of safe assets at all times, but governments are being pressured into eliminating structural deficits. These two aims simply are not compatible. No government can run a balanced budget AND issue debt for any length of time without impoverishing its population. It would amount to fiscal transfers to foreigners. The effect would be rather like war reparations.

    2. As I have no truck with the gospel according to the IMF, and the dominant obsession with "balancing the books", I certainly sympathise with your concerns.

      Interestingly, the strongest commitment governments can make to the safety of their securities <> is to extricate themselves from the position of obligor: this can be done by issuing securities that are not redeemed by the government but by the holder returning them in settlement of future tax.

      This was once the practice. Tallies, for example, were an effective means of financing premodern English government; because they could be returned to the Exchequer by tax-paying citizens, their integrity was never called into question. They were, in effect, broad money. Such a solution is available to constrained Eurozone countries like Italy, but there is no reason that others could not do likewise. Thoughts?

    3. Phew. We are on the same page really. I think the current obsession with fiscal consolidation is insane. It's driving the entire world into a slump, and it's completely missing the point. We have a fundamental change in the nature of money. Fiscal consolidation is monetary tightening.

      My only reservation about using government securities as tax credits is that many of them are owned by people who don't pay tax - the elderly. And those people need to be able to draw them as money. They can do so by selling them, of course - but if they held them to maturity it would be very cruel to make them effectively irredeemable. But yes, being ABLE to use them to settle tax liabilities would firmly establish them as high-powered money, which is what they are, really.

  16. The traditional safe haven provided by governments has been "CASH". It pays no interest. Given it is denominated in a currency issued by the sovereign, who enjoys exclusive franking privileges, there is no default risk.

    There is however, inflation risk.

    The traditional method for dealing with that risk, was to park funds in cash for short periods only, before investing them in inflation hedged assets.

    I believe Frances intimates that the provision of truly "risk free" investments by government, eliminates incentives necessary for banks to lend to "main street".

    Therefore, it is essential that banks like everyone else, find it impossible to park money risk free.


  17. People are pessimistic and are afraid of the future. I can understand that. But, I saw yesterday evening a program on the French television where an economist claimed that new data demonstrates that the economic situation is not catastrophic and all this psychosis is due to a mistake in calculation of certain economists. Where is the truth?

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