Friday, December 4, 2015

Dissecting the Don

6 months ago, I was worried that the 2016 presidential election was shaping up to be one of the most boring in modern history. The conventional wisdom at the time was that Hillary and Jeb would go against each other in the 2016 Battle of Bores with Billions. Now, with Donald Trump polling in the high 30's with only three month until Iow and New Hampshire, that prediction was, thankfully, far off base.

Trump's success has come to the surprise of most of the US political establishment, media, and punditry. Nobody took his campaign seriously during the few weeks before the first Republican debate, and following the debate, most pundits thought he was finished. Of course, now we know that the exact opposite was true (and that most of the political punditry is worthless).

The same pundits that got everything wrong so far have taken to writing hundreds of complicated articles dissecting the Trump phenomenon, and predicting when or if it would end. But as I see it, the reason for his success is actually quite simple: Donald Trump understands, perhaps better than anyone, that political language no longer has any meaning. American political discourse has been rendered meaningless by decades of Orwellian tactics by the right wing political and media machine. The media, which is supposed to be the caretaker of objectivity in national political discussions, has for decades been complicit in the conservative takeover of the US political economy and therefore has little to no legitimacy in the eyes of the American public, which has been economically crippled and politically marginalized by neoliberalism. The media can yell and scream all day long about the vile, racist, and borderline-fascist comments made by Trump and his supporters, but it will have little to no impact. To steal a line from"Who's Line", 21st century American politics is a place where "everything is made up, and the facts don't matter." 

Trump understands that the political process has no integrity or legitimacy, so he treats it with all the respect it deserves-- which is to say, none. Unlike the more serious establishment GOP contenders, Trump doesnt bother to act as if any part of the process is worthy of anything in and of itself. He sees it as purely a means to an end, and doesn't care how he gets there. And he probably knows that the reliably short-term memories of the American electorate will allow him to soften and regulate his tone during the general election, and res-cast himself as a practical businessman who just want to "Make American Great Again!!!" Watch for his tone to drastically soften once he has sewn up the primary.

I suspect Trump also knows that policy proposals, especially during hotly contested primaries, are a joke. That's why his plan to cut taxes by $10 trillion, regulate health insurance at the federal level, and deport all illegal immigrants are so absurd. Since these proposals are meaningless anyway, why not go full-on right wing to suck in as much of the base as possible? So far, this has worked better than any political analyst could have imagined. This also happens to be a perfect strategy for wooing in a Republican base that has been conditioned to angrily reject nuance and analytic thought.

It is also hard to overestimate how much Trump's ascendancy scares the shit out of the Republican establishment. Trump has swiftly hijacked a political and media machine that many in the GOP establishment have spent their entire lives crafting. From the Powell memo to Citizens United, the GOP has built a system of electoral repression and unbridled corporate financing that they thought would cement their political power for a generation. Then along comes Donald Trump, a billionaire with no political experience, who simply manhandles their entire operation and forces it to his own personal advantage. He easily dispensed the  'inevitable' $125 million Jeb Bush campaign with a few zippy deliveries of the novel "low-energy" line. All the right-wing SuperPACs, attack ads, pundits, analysts, and even Fox News, were no match for Trump's "high energy", wealth, and force of personality. Trump has brow-beaten them all into submission and now has a clear path to the nomination.

Keep in mind, Trump is really not a right wing conservative at heart. He is more likely an Eisenhower Republican, who believes that government has some sort of proactive role in the economy, to do great, 100% yuge things, Big League.  And in all honesty, Trump is a good representative for the United States at the moment- White, slightly overweight, aging, loud, rich, and rabidly unapologetic.

That's why nothing Trump says, controversial or mundane, matters at this point. He's little more than a political opportunist who saw a right-wing base that was ripe for the picking. He took one look at the field of so called "inevitable" Republican candidates, and thought out loud "Hey, I can do better than these bozos!"-- and so far, he has.

Thursday, November 19, 2015

Obama's Arbitrary Approach to Arbitration

Much noise has been made in recent months about the pending Trans-Pacific Partnership (TPP) agreement currently working its way through Congress. While recent reports have indicated that the deal may have stalled in Congress, I think its still worth noting one element of the deal that reveals a startling hypocrisy from the Obama administration.

While the Consumer Financial Protection Bureau (CFPB) begins its foray into regulating the world of private arbitration clauses, a different agency of the Obama administration is taking on the opposite approach. While the CFPB's efforts are to be applauded,any improvements that may result domestically will be offset by the international devastation that would arise from a particularly nasty provision of the TPP.



A little background on arbitration:

The CFPB's rulemaking, if finalized, would be the first attempt by the federal government to crack down on the ballooning use of what are called "forced" arbitration clauses, which appear in all sorts of commercial contracts: from real estate leases, to cellphones, and cars. Forced arbitration clauses routinely are inserted into the fine print of contracts that people must sign to buy a product or service or get a job. Millions of Americans are inadvertently signing away their rights to sue the entity they are doing business with when they sign these agreements. Arbitration is a process in which a private firm is hired to settle a dispute without going to court. It was designed as a voluntary alternative to actual litigation.

While the language varies, the point of arbitration is to shield business from their customers suing them, especially through class-actions suits. Whether they know it or not (usually not), the consumer agrees to have their issues settled by a private arbitrator, who is not an appointed judge of any town, county, or state. These arbitrators are often selected by the business itself, which presents a obvious conflict-of-interest problem and stacks the deck against the consumer and their attempt at redress.

Arbitration is now a tool used by corporations large and small, to force consumers and employees to surrender their right to hold corporations accountable for wrongdoing before a real, governmental court. The main selling point of the pro-arbitration crowd is that it is "discount justice"-- consumers can get some form a redress quicker and cheaper than through the actual justice system. No need to hire one of those slimy lawyers, file a lawsuit, or appear before some crotchety old judge.

While at first glance it may seem like a more efficient system, arbitration is a way for powerful corporations to evade responsibility and rule of law. Under forced arbitration, individual consumers or employees must fight it out before a private arbitrator essentially chosen by the company that cheated or discriminated against them. Arbitrators do not need to be lawyers or follow precedent, yet their word is nearly always final and unappealable.

Nearly all forced arbitration clauses also ban class-action suits, which allow individuals to band together to bring their common claims against big corporations. Without the ability to band together, individual claims are usually too small for any one person to bother with the costs of litigation, allowing shady companies to do small amounts of harm to a large number of people without consequence. The whole false right-wing narrative about "frivolous lawsuits" has empowered the stunning growth of these clauses over the past decade.

In my view, these hidden arbitration clauses also violate the very spirit of our Constitution, which supposedly provides equal protection by, and access to, government for the redress of grievances.

So while CFPB (an agency which Obama himself signed into law) takes on the issue domestically, the White House is burning through what is left of its meager political capital to push through the widely-despised Trans-Pacific Partnership "trade" deal on the international level. At the core of the TPP is the so called "investor-state dispute settlement" (ISDS) system, which is basically a globalized arbitration panel.

These international panels grant extraordinary new rights and privileges to foreign corporations and investors that formally prioritize corporate rights over the right sovereign nations to govern their own affairs. These terms empower individual foreign corporations to skirt domestic courts and directly challenge any policy or action of a sovereign government before World Bank and UN tribunals.

Comprised of  private attorneys, the extrajudicial tribunals are authorized to order unlimited amounts of compensation for health, environmental, financial and other public interest policies that don't fit corporate interests. The amount awarded to corporations is based on the "expected future profits" that the corporation would have earned in the absence of the public policy it is attacking.

This panel would provide a super-national platform for multi-national corporations to sue sovereign governments. If a government proposes, for example, a new series of environmental regulations that impose costs on a corporation, that corporation can bring suit against the government with the ISDS, in an attempt to stop the regulation or receive compensation for compliance costs and any potential profit losses emanating from the regulation. This arrangement already exists in a more limited form at the World Trade Organization, where suits can be brought against countries who impose trade barriers.

ISDS is essentially arbitration on steroids. Just as consumers are disempowered by forced arbitration domestically, sovereign nations are disempowered by arbitration internationally. This expansion of private, unaccountable corporate power is antithetical to every democratic ideal, and is a horrifying reversal in the gradual expansion of global democracy that occurred in the 20th century.

The passage of TPP would symbolize yet another weakening of national democratic sovereignty. Democratic government would be powerless to appeal decisions of this international arbitration panel, which is controlled by neoliberal, corporate interests and ultimately not accountable to anyone. By creating a platform for corporations to overpower national governments, the TPP would codify the dominance of global corporate power, which has grown exponentially in the past 30 years.

That a former Constitutional law professor would have anything to do with such a flagrant offense to a core principle of the US Constitution is notable enough. But the fact that his White House is pushing to expand corporate-friendly arbitration on a global scale is particularly disgusting. If implemented, this panel would represent another step in the corporate globalization.

So while this scheme may seem rather odd, I don't mean to suggest that this policy incongruity is surprising. In fact, it fits right into the current dynamics of DC policymaking- make some highly visible domestic policy moves to keep people placated, while moving behind the scenes in opposite, more pernicious ways.

Thankfully, the threat of the TPP has mobilized grassroots movements and mass protests across the globe in opposition. And just about every presidential candidate, both Republican and Democrat, currently opposes the TPP. Neoliberalism may have finally gone to far. The tide may finally be turning.

Monday, November 9, 2015

Power is Money

Since bank lending creates the vast majority of the money supply, bank lending controls the vast majority of resource allocation in our economy. That’s why it is extremely important that policymakers fully understand the banking system, and why it’s so tragic that they don’t.

From a political perspective, realizing how much of the money supply, and therefore allocation and distribution of real resources is controlled by bankers, is very difficult. It is not easy to acknowledge that most economic activity is dictated not by our democratically-elected government issuing money as it spends, but by profit-chasing bankers living it up as overpaid bureaucrats. The vast majority of what we call money is not created by government spending, but by private bank lending. This realization forces one to rethink their approach to all public policy issues, since public policy always involves resource allocation in some form or another.

Every individual and every industry in this country relies on the banking system in some way, so it’s important for all of us to understand how it actually works. The first step in this process is to throw out any preconceived notions about how you thing banking works, because they are almost certainly outdated at best, and totally wrong at worst.

Recognizing banks as credit allocation utilities, and not intermediaries of preexisting savings, changes everything. All economic models get blow up once the reality of money as a measurement tool, and not a quantity the price of which is determined by supply and demand, is realized. Therefore, since most economic models treat interest rates as a reflection of the supply/demand for money, these models become useless. All the efforts by economists to derive meaning from interest rates (what is “natural”, what is the “equilibrium rate”, Taylor Rule, etc) are a complete waste of time, and distract from the necessary focus on what is happening in the real economy.  

Fiat currency is a unit of measure and a medium of exchange, and it works great in those roles. Savings of fiat should be a completely separate activity from the day to day transactions in the formal monetary economy, not artificially linked to the medium of exchange in some kind of metal commodity. Fiat costs nothing to produce, and is unlimited in supply. Its value is ultimately derived by the fact that it is the only thing that the US government will accept for tax payments, which it imposes to the tune of $3 trillion a year. You can’t pay your taxes with gold coins.

When the banking system lends money into existence, it only does so for the purposes of yielding a positive financial return. This can be a very useful incentive to drive many different types of commerce that an economy needs to thrive. But no sensible person could argue that all money creation should be directed only towards profitable enterprises. There are many things beneficial to human society that cannot be achieved under a profit motive. Public infrastructure, retirement security, education, healthcare, defense; these are all things that we acknowledge in some form need to be managed by the governmental sector, since they are both necessary to our lives, yet not always feasible when run for a profit. There is no line in our Constitution, or precedent in human history, that says that society should be solely, or even largely organized around markets.

One main example is the incorrect economic argument that government borrowing raises interest rates by “crowding out” funds that would otherwise be available for nongovernmental use. However once one realizes that the money supply is not fixed, and in fact largely influenced by bank lending, this point becomes moot. Government “borrowing” could not possibly increase the cost of bank lending, since there is nothing than the banks would otherwise use that is being “crowded out.” As previously described in this blog, bank lending is merely the creation of a new account balance for the borrower. This occurs through the simple process of a loan officer typing a number into a keyboard. Nothing pre-existing is “used” to create the loan balance; the money is simply typed into a computer, much like any email or spreadsheet, and created from nothing.

This leads us to the peculiarity of modern day discussions about political economy, both among regular Joes and the policymaking elite around the world. For some reason, public money creation is given far more attention than is necessary, while private money creation, in addition to being a much larger force that can quickly become unsustainable, is mostly ignored. The massive housing bubble in the run-up to the financial crisis was ignored by almost all the economics profession, while the public money expansion in the years after, caused by necessary increases in government debt around the world, was given disproportionate attention by the chattering classes. 

In neither period was the difference between public and private money creation ever discussed in a significant way. When he looked back at the last 30 years of economics, the UK’s Lord Adair Turner expressed his dismay that the economics profession had obsessed over fiscal policy and levels of public debt, while entirely ignoring the levels of private debt which ultimately caused the financial crisis.

The power to create money is one of the greatest powers in the world, second only to use of physical, military force. It could be argued that money creation is even more powerful, because it occurs all day, every day, in manner so mundane as to attract nearly no attention. If the US government, for example, sent Marines to point guns at bankers, mortgage brokers, builders, contractors, and construction workers, and ordered them to build 1000 new houses, the American public would rightly be horrified. But when the quasi-governmental banking system lends money into existence for mortgages (FDIC insured banks), the government insures billions of dollars of mortgages from failure (FHA/VA/FCA), then packages mortgages into securities (Fannie/Freddie), and then buys these securities (Federal Reserve), all of which has roughly the same effect as the previously described militaristic scenario, no controversy is stirred. The same public purpose was achieved, but with totally different means.

So instead of provisioning Americans with housing with use of physical force, the government supports the current monetary system in all its complex machinations. From a purely macro point of view, if power is defined as the ability to deploy real resources for a desired purpose, then both physical force and money issuance are forms of power.

Of course, I don’t mean to suggest that the government should use physical coercion to deploy the nation’s resources. Our current financial arrangements have the capability of doing this peacefully and somewhat efficiently, although improvements obviously need to be made. The first, and biggest step toward making these improvements is educating the public about how the nature of modern money and how the banking system accurately works, so voters can make informed decisions about the policy decisions that their elected officials make in this space. 

Wednesday, November 4, 2015

The Missing Link on Gun Violence

The term 'Senseless Tragedy' should never be applied to mass shootings. Its a crass capitulation to willful ignorance; a weak attempt to confront brutal reality. Mass shootings are never senseless. There is always a reason, always a force that drives men into madness- to take the lives of their fellow citizens. With every tragic mass shooting, an attempt should be made to delve into the dark minds of these killers, to find out what really drove them. But this never seems to happen. Instead, people express "shock", "horror" and "outrage", that "something must be done." Then begins the same old song and dance. The left impulsively calls for more gun control. The right reacts with insane rhetoric. And then....nothing happens.

Perhaps a new approach is needed. Perhaps we should actually take a look at what conditions in modern America, whether economic, social, or otherwise, lead men to these horrifying actions. A common reaction is to blame violence in TV, movies and video games. But this violence exists in media all over the world-- this factor needs to be ruled out, or at least moved to the back burner for now.

So what do some of the perpetrators of the worst mass shooting in recent years have in common? A quick glance reveals a stunningly obvious similarity. With one exception, the killers at Columbine, Virginia Tech, Aurora, Newtown, Isla Vista, Charleston, and Roseburg were all white, suburban, 20-something males. They were not raised in urban areas, or around street violence. They didnt necessarily have genetic mental health issues, and had no previous criminal records. These were not your typical murderers. But they were driven to sociopathy nonetheless.

However, the vast majority of gun deaths in our country dont come from mass shootings. They come from the day in, day out homicides that occur regularly in the towns and cities across America. It's a well established fact that financial stress is the number one contributor to domestic violence and divorce, which, in turn, becomes a breeding ground for gun violence.

At this point, it is nearly pointless to try and regulate the tools that lead to these shootings. The fact that Americans collectively own around 300 million guns means it will be impossible to substantively reduce their availability. And while clip limits and universal background checks may make some difference, critics of those methods accurately point out that many of the mass shooters would not have been stopped by these methods anyway.

The gun issue is beyond politically contentious. For decades, Republicans have refused to budge an inch -if the Sandy Hook horror couldn't get congressional Republicans to move on guns, absolutely nothing will. It seems to me that Democrats have already wasted enough political capital on this intractable mess . The power of the NRA's grassroots network in keeping Congress scared is the envy of all lobbying organizations in Washington. It's easy for Democrats to attack powerful business interests, because they dont actually have a large, natural constituency. But guns, unlike any other personal possession, hold a unique psychological grip over the millions of Americans who make up the NRA's membership.

At this point in the trajectory of this issue, it seems to make much mores sense to address the underlying social and economic conditions that lead young men to such acts of violence.

40 years of brutal neoliberalism has drained the country of its vitality. Maybe by destroying the middle class, wiping out upward mobility, eliminating blue-collar jobs, busting unions, neoliberalism has gutted the country and left nothing but misery in its wake.

In so many communities throughout the country, anger boils just below the surface. As humans, we thrive on potential. It is the potential of improving ones lot in life that gets most people up in the morning. The American dream of working hard and having a secure, comfortable life is more than enough for most people. And when that potential is cut off, by making jobs unavailable, by making college too expensive, by forcing people to work multiple low paying wage jobs, anger naturally ensues. When taking on debt becomes necessary to meet basic needs, when an emergency room visit costs $2500, and a years worth of medication costs more than a car, people lose hope. The dreary by-products of neoliberalism grind everyone down- some to complacency, some to exhaustion, and others, tragically, to horrifying violence.

As social animals, our states of mind are mostly relative. That's why saying that the poor/middle class in America are better off than the poor in other countries is a useless argument.  The fact that we had a middle class, and then lost it, is much more painful than if we had never had a one at all. Falling out of the middle class hurts a hell of a lot more than climbing up to it.

So what happens when a 20-something male looks into his future and sees nothing but drudgery? When the energy and hormones, which spring naturally at this age, cannot be directed towards productive paths forward, they are instead directed inward.  Social estrangement is obviously nothing new, but it can usually be assuaged by focusing on the future, on a career, or on a family. But when these channels for personal success are also blocked off, the pressure builds into internalized rage. This rage can become all-consuming. And when ubiquitous social media makes it easy to see how well other people are doing, the rage can explode outward in violent expressions.

Contrary to the NRA's inane talking point about " a good guy with a gun vs a bad guy with a gun", there is no such thing as good guys and bad guys. Just as all of us humans are capable of acts of compassion, all of us humans are capable of descending into violence. Unfortunately, the crushing reality of modern American life often leads to the latter.

Thursday, September 24, 2015

Identity Politics and the Sclerosis of the American Left

We are at an interesting point in American history. We are at the apex of a 40-year triumph of neoliberal ideology in the US, and in fact, the world. At a time where public policy challenges are greater, and more global than ever, governments are less capable and less functional than ever. As a gridlocked Congress and lame-duck executive now struggle to pass the most basic of bills to keep the government open, its worth taking a look at how exactly we got here.

A quick look at our own history reveals it was not always this way. The Greatest Generation of voters and policymakers dug the country out of the Great Depression, fought a massive war on two fronts, and completely re-built the American economy in relatively short period of time. They were driven by more than just the necessities of winning wars and stopping depressions; they knew their work was deeply meaningful. They were changing not just their own lives but the entire trajectory of human society.

The unparalleled prosperity in the years that followed became its own worst enemy. The relative peace and prosperity of the post-war years led to a vacuum of meaningful employment and public engagement. The advertising Mad Men of Madison Avenue took full advantage of this vacuum, filling it with a potent, but pernicious focus on the self, on consumption, on branding, and in the process created a radical new way of forming human identities.

No longer was self-sacrifice  for the greater good a significant focus of people's lives. As the first generation of humans to be inundated with advertising from birth, the baby boomers unwittingly became a massive experiment in human social psychology. The new self-importance of post-New Deal American politics served perfectly the social movements that followed, and coalesced easily into the economic revolution of the last three decades.

The movements that shaped the baby boomer identities were uniquely uneconomic in nature, standing in stark contrast to those of their fathers. The Civil Rights, gay, and women's rights movements, along with sexual liberation while important, were movements focused exclusively on human identities. Discussions of economic power were almost entirely absent from these movements.

Perhaps no man embodies the rise of neoliberalism than Milton Freidman. Through his adept use of public media outlets to promote his radical message of market fundamentalism, Freidman was able to direct his message of individualism to a young audience eager to separate itself from the New Deal mentality of its parents. While the baby boomer motto of "dont trust anyone over 30" expressed frustration with the social conservatism and militarism of the previous generation, it, perhaps unintentionally, also condemned the New Deal values of class solidarity and economic struggle that had created the American middle class. As these values faded from America's political consciousness, they were replaced by the Freidman-esque focus on individual identity, freedom of self promotion, and adversity to leadership from the national government.

The last 30 years has show us that these identity-bases affiliations are as fragile as they are convenient. The absolute lack of any meaningful leadership from American politicians since the 1970's is plain evidence of the weakness of identity based politics. Not since Lyndon Johnson has a progressive politician taken the national stage and gone to bat for the bread-and-butter issues that are most important to America's middle class. The rise of identity politics has limited liberal movements to peripheral social issues, that while important, were addressed at the neglect of the core purposes and functions of national government. And once Ronald Reagan appeared on the scene, preaching an unapologetic message of greed, selfishness, and material prosperity, the identity politics generation was pulled right in. By this point, the Democratic party had been weakened by such an extent by identity politics, and had moved so far away from the bread-and-butter issues that had been its core, that it could not muster an effective opposition to the Reagan Revolution (and still cannot, to this day).

Neoliberalism thrives on identity politics. At first glance, neoliberalism is sleek, modern, and unoffensive. It can be easily explained and transmitted, like a zombie virus, through introductory college textbooks. It does not trip the political sensors of the identity politics generation. Unlike racism, sexism, or homophobia, it does not seek to deliberately sensor, constrain, or manage human behavior. But it ultimately does so, to a much greater extent, through a crushing blend of government power and corporate avarice. As a result, it has successfully slipped under the radar of so called "liberals" in the United States to an incredible degree, leading us to the economic dystopia we find ourselves in at the present day.The rise of unconventional candidates like Donald Trump and Bernie Sanders are clear indicators of the anger of the mass of America which has slowly and quietly been economically dispossessed by neoliberalism.

The state of black America is perhaps the clearest example of how identity politics feeds neoliberalism. The civil rights movement was a legal victory that culminated with the passage of the Civil Rights Act of 1964 and Voting Rights Act of 1965. The passage of those laws finally brought an end to the overt, institutional racism of American government. No longer was political power being used to constrain minorities in such obvious ways. Ironically however, these legal victories created a veneer of political success that allowed neoliberal economic policy to thrive, which in the end dis-empowered and dispossessed Americans of all stripes, to a degree not seen since before the civil rights victories had been achieved. Poverty, unemployment, and discontent--all the products of neoliberalism- are now nearly as tragically common as before the civil rights victories of the 1960s.

And these legal victories were not economic ones. As Dr. King knew all to well, the larger struggle was for economic rights. After the 1965 Voting Rights Act, King focused his efforts largely on economic issues, fighting for higher wages, union rights, and job guarantees. His assassination took place following a march in Memphis, Tennessee, in support of the black sanitary public works employees who were striking for higher wages. None knew better than King the importance of universal, guaranteed employment. Far more effective than any handout, subsidy, or welfare program, a job guarantee is all inclusive. It hires anyone wiling and able to work. Unlike other welfare programs, it could never be perceived as a special advantage given to favored minorities. This latter part of his legacy has been largely forgotten, but in King's own words it was equally important.

And while minority issues are important matters of national policymaking, they are, by definition, not the issues of importance to the majority of American citizens. In a nation built on the principles of majority rule, a focus on minority issues cannot be a successful electoral strategy. Therefore, the increasing focus of liberals on to issues that don't affect the majority of the country has created enormous political backlash, and come at the expense of the necessary focus on economics and the power dynamics of global capitalism.  Equal rights are much more effectively addressed through the court system, where calm, judicial analysis can be made on a case by case basis, away from the heat and tension of electoral politics. As the triumphant LGBT activists have recently demonstrated, using the judicial branch of government, instead of the politically sensitive legislative and executive branches, is a far more effective strategy for bringing about equality.

Perhaps nothing is more emblematic of the triumph of identity politics, and the sclerosis of the American left, than the ascendancy of Hillary Clinton as the heir-apparent of the Democratic party. In no other time in the history of the post-New Deal Democratic party would someone who had been so close with the economic and politically powerful be considered a viable candidate. In no other time in the party's history would someone whose main name recognition was largely due to spousal choice and not administrative success be an  implied front-runner. Yet here we are. The simplistic desire of the identity generation to have "the first female president" seemingly trumps her enormous flaws, both on her policy views, and as an effective candidate. The power of the Clinton dynasty is due entirely to the triumph of liberal identity politics.

On economic issues, the Clintons are far to the right of Richard Nixon (and their political cynicism makes Nixon look like a amateur). Their hostility to the well-being of the blue collar, unionized American working class is unparalleled in Democratic Party history, as is their post-government coddling by the corporate community.  It is only because of Hillary's perceived "progressivism" on the issues close to the bleeding hearts of identity liberals that she is anywhere close to being the party's nominee.

Never in the course of baby-boomer adulthood has a movement arisen to challenge the backward slide of the American middle class, the militarization of police, the rise of post-9/11 security state, or the impending catastrophe of climate change. No, as long as those 401(k) balances and home equity values kept going upwards, the boomers didnt make a peep. Identity politics ultimately makes for a crass, shallow, and fickle basis for political identification.

The rising insurgency of Bernie Sanders in the US and Jeremy Corbyn in the UK, along with the bold leadership of Pope Francis, may be indicators that this 40 year old political dynamic may be finally changing. The pendulum may now be swinging back to the bread and butter issues which delivered the New Deal Democratic party near total control of government for decades. Nothing could be more frightening to the global cabal of  neoliberal elites. And nothing could be more necessary to the prosperity of man and earth.

Wednesday, August 19, 2015

7 Questions about the recent banking scandals that you were too afraid to ask

Banks and bank regulators have been in the news a lot lately. You may have heard stories about how banking regulators often get too cozy with the bankers they are supposed to keep an eye on. While this has been a pernicious issue for years, two recently publicized scandals have brought this problem into the news.

Both of these recent controversies surround two former employees of Federal Reserve Bank of New York (FRBNY), and their relationships with the megabank Goldman Sachs. These stories have revealed the blurry and often complex nature of the relationship between regulators and powerful banks. These stories also exemplify the persistent problem of something called “regulatory capture”, which, while sounding like a dusty legal topic, is actually a very important issue that can affect the whole economy.

The first of these two controversies arose in October, when a Carmen Segarra, a former employee of the Federal Reserve Bank of New York, released several audio clips that she had recorded while still employed at the Fed. These tapes included conversations between Segarra and her bosses at the FRBNY, as they discussed some controversial business practices being made by Goldman Sachs.
Segarra was frustrated with the light treatment and relaxed attitudes that her higher-ups had towards this behavior at Goldman, which she perceived to be unethical and potentially dangerous. Segarra was a permanent on-site examiner at Goldman Sachs during her brief tenure at the Fed, and claimed that the Fed's lackadaisical approach to supervision led her to record, and later release, these conversations. These substantial disagreements ultimately led to her dismissal from the Fed in 2012. Then in October of this year, she released a few minutes of her tapes and sat down for a lengthy interview with NPR.

Recently, news broke about unethical behavior of a former employee of the same Federal Reserve Bank of New York, who later went on to work at Goldman Sachs. This former examiner named Rohit Bansal was caught using data from his time as an examiner and his connections with the FRBNY to benefit his new role at Goldman Sachs.


1) So, what’s the problem here?

The audio tapes that Segarra released revealed that senior staff at the FRBNY frequently gave Goldman Sachs a lot of regulatory deference and went easy on Goldman employees when they made questionable business decisions. The tapes focused on conversations between Segarra and her colleagues, who were all part of the FRBNY’s examination team stationed at Goldman. The most revealing quote from the tapes comes from Segarra’s boss, who almost laughingly described one business deal of Goldman’s as “legal, but shady.” Expressions like these were exactly the reason Segarra recorded internal conversations at the FRBNY--which ended up coming in handy once she was fired. It’s clear from the rest of these tapes that Segarra’s willingness to stand up to Goldman’s behavior was resisted by her superiors and likely led to her termination from the Fed.

A few weeks later the New York Times reported on yet another scandal between Goldman and the FRBNY. The article revealed that a former FRBNY employee Rohit Bansal had been caught using private government data at his new job at Goldman. Bansal had worked for the FRBNY for several years, and by the time he left the Fed, he was the central point of contact for certain banks.  Once Bansal joined Goldman, he used his expertise, along with his relationship with a former FRBNY colleague, to illegally acquire confidential regulatory information about a client that Goldman was doing business with.

Once this leak was discovered, Goldman immediately fired Bansal, and FRBNY immediately fired the man who they believed to be the leaker. The severity of these leaks became obvious when only days after Goldman reported the breach, federal authorities, including the FBI, FDIC, and the US Attorney for the Southern District of New York, began an investigation into the matter to see if any crimes were committed.

2) I think I’ve heard of Goldman Sachs before, but what exactly is it?

Goldman Sachs is one of the largest banks that many people haven’t heard of. That’s because Goldman Sachs is not a commercial bank like Bank of America, Wells Fargo, or Citi, that consumers can directly do business with. Goldman is organized as something called a “bank holding company”, which is a fancy term for financial conglomerate. Goldman does many things, but hosting checking/savings accounts and making consumer loans are not among them. Goldman is actually an investment bank, which means it deals only with other companies, and not directly with consumers. Its major business lines include giving merger and acquisition advice, managing assets, engaging in private equity deals, and serving as a financial broker for other corporate clients.

3) What’s a bank examiner?

In the US, there are two major steps to regulation: rulemaking and supervision. Regulatory agencies first have to write the regulations for their respective industry, through a public process called “rulemaking”. Then, once these regulations are finalized, the agencies must also make sure that businesses are complying with them. This ongoing, complex, and often fuzzy process of ensuring compliance is called ‘supervision’, and its where these two recent scandals have occurred.
In general, government agencies that supervise banks, at both the state and federal level, have employees called ‘examiners.’ These examiners are people with expertise in accounting and regulatory compliance who go on-site to the banks that are under their supervision and conduct bank exams. During these exams, examiners comb through bank balance sheets, policies, practices, and interview bank employees--all to ensure that the bank is properly complying with regulations. Different agency examiners have different jurisdictions and look for different things-- for example, examiners from the Consumer Financial Protection Bureau might look to make sure a bank isn’t unfairly charging its customers, while examiners from the Federal Reserve might check to make sure the bank isn’t making too many risky loans.

While smaller banks might only go through exams occasionally, megabanks like Goldman Sachs have teams of examiners on site permanently, since their business practices and balance sheets are so large and complex that they require constant review. Carmen Segarra and Rohit Bansal were two such examiners.

4) But wait, isn’t the Federal Reserve a private bank?

Well, it’s complicated. Most people know the Fed as the organization that sets monetary policy and manages the currency, buts its lesser-known role as a powerful bank regulator is just as important. The Federal Reserve is actually a system, composed of 12 regional banks located in major cities across the US, and the Board of Governors, which is located in Washington, DC. The Board of Governors is just that-- a board of seven men and women who write regulations for the banking system, make policies for the 12 regional banks, and oversee their activities. These seven governors are nominated by the US President and confirmed by the Senate, just like the heads of other government agencies. The Board of Governors, more than any other part of the Federal Reserve System, most closely resembles a federal government agency. It has a “dot-gov” web address, pays its employees on a public pay scale, and regularly reports to and testifies before Congress.

The 12 regional banks, while they are ultimately controlled by the Board of Governors, function more like private banks and have their own boards of directors. The presidents of these banks are privately selected without input from the US President or Congress. Banks like Goldman Sachs, which are regulated by these regional banks, are also members of the regional banks, and have some influence into how these banks are run. The Federal Reserve’s examiners, like Segarra and Bansal, are employees of these regional banks.

The most powerful of the regional banks is the Federal Reserve Bank of New York (FRBNY), where both Segarra and Bansal were employed as examiners. The FRBNY, located in downtown Manhattan, is responsible for regulating and supervising banks in the New York area, which is to say, many of the world’s largest and most complex banks like Goldman Sachs.

Ultimately, the president of the FRBNY is the most responsible for the behavior of the examiners, and the banks they regulate. The president of the FRBNY is a very powerful position, so the person filling the chair is usually well known around Wall Street and Washington. For example, the last president of the FRBNY was Timothy Geithner, who went on to become Treasury Secretary during the first four years of the Obama administration (not surprisingly, Geithner’s predecessor at the Treasury was Hank Paulson, who had previously been the CEO of Goldman Sachs). The current FRBNY president is a guy named William C. Dudley, who formerly served as chief economist to….Goldman Sachs. Not surprisingly, Mr. Dudley’s name has shown up in the news a bit lately, and he also appeared before Congress a few weeks ago.

5) Is “regulatory capture” as scary as it sounds?

It can be! Regulatory capture is a term used to describe how regulatory agencies, like the FRBNY, can be ‘captured’ by the business that they are supposed to regulate. Capture is often demonstrated when government regulators go easy on businesses, potentially because they may be seeking higher-paying employment with these businesses in the future. This is a particular problem in the world of financial regulation, because government employees often make far less than the bankers they are regulating. It’s not uncommon for regulators to quit their regulatory jobs and go work for a bank, often for two or three times more than their government salary. So if regulators are going about their jobs with future employment in mind, it can compromise their ability to adequately enforce the laws on the books. Even the best written laws aren’t any good if they aren’t firmly enforced, so bad regulatory capture can put the banking system, and the entire global economy, at risk.

6) So what (if anything) is Congress doing about all this?

In mid-November the Senate Banking Committee held a hearing entitled “Improving Financial Institution Supervision: Examining and Addressing Regulatory Capture.” This hearing featured testimony from FRBNY President William Dudley, and lengthy questioning from several Democratic Senators. Most notably, Senator Elizabeth Warren (D-MA) grilled Dudley about the FRBNY’s capture problem, his role in these two scandals, and his seemingly dismissive attitude about them. Warren and Dudley went back and forth for much of the hearing, and the conversation got testy at times.

At the same hearing, Senator Jack Reed (D-RI) introduced a bill that would require the president of the FRBNY to be nominated by the President and confirmed by the Senate, much like the Fed’s Board of Governors is currently. Reed’s legislation would also require the head of the FRBNY to testify before the Senate Banking Committee and the House Financial Services Committee at least once per year. Other proposals that were raised at the hearing include removing the Fed’s regulatory and supervisory powers and giving them to another agency like the FDIC, which is not traditionally as cozy with the banking industry.

7) But I thought the financial reform law was supposed to change things!

Well, the 2010 Dodd-Frank financial reform law did do many good things. It created an entirely new and powerful agency, the Consumer Financial Protection Bureau, to focus solely on how financial institutions treat their customers. It also created an umbrella organization, called the Financial Stability Oversight Council (FSOC) to oversee the federal government's entire approach to financial regulation and coordinate activities among the different agencies.

That being said, the Federal Reserve as a system was not significantly modified by the Dodd-Frank law. Although the Fed was given expanded regulatory and oversight powers under the law, its structure and culture remain largely the same as before the financial crisis. Senator Jack Reed’s recent proposals, which were included in early drafts of Dodd-Frank but later removed, would allow Congress to keep a direct eye on the FRBNY, instead of only through the Board of Governors. Although unlikely to become law in a Republican controlled Congress, these proposals would bring a significant change to the current relationship between Congress and the Fed.  

The problem of regulatory capture clearly remains. Even though employees of the bank regulatory agencies usually make more money than other federal employees (because they are exempt from the traditional “GS” pay scale), they still make far less than their counterparts in the financial industry.  The allure of lucrative post-government employment is a difficult phenomenon to reverse, especially in the current political environment where government agencies are subject to continuous sequesters, shutdowns, furloughs, and pay freezes. However, perhaps more important than compensation is an agency’s culture and understanding of its role in the economy. Segarra herself put it best-- when asked what was ultimately lacking at the Fed, she replied “lack of backbone, transparency, thoroughness and perseverance.”


Friday, July 10, 2015

Weather Greece

With the Greek Grexit now nearly Grenevitable, discussions have shifted from "if" to "how." If Greece does in fact dump the euro and bring backs it old currency, the drachma, how will it go about re-organizing its economy? How will it deal with the inevitable devaluation of the new drachma against the euro? What will the Greek people be able to produce and consume under this scenario?

The questions are many, and there are no simple answers. However as I did in a previous blog post, I will discuss the issue in the context of a computer game I played as a child. That game was called Caesar III, which was a real-time strategy game where the player is the mayor of a certain city in the Roman empire. This town is built from scratch on an an empty map, and their are multiple moving parts and pieces that need to fit together in order for a successful city to be built. One crucial aspect of the game is that no one of the map choices has all the resources needed for prosperity. As the game continues, the citizens of your city begin demanding a wider variety of foods, drinks, and household items. Since no one map is capable of producing all these things, trade with other cities in the Roman empire becomes a necessity for success.

This trade scenario requires the player to decide how much of a particular specialty good needs to be produced for all its citizens' needs to be met, while also having enough to trade to other cities in exchange for their specialty goods. For example, one of the maps has a lot of marble, but no iron to make weapons. So in that city, you focus on producing as much marble as possible, and trading it for weapons produced by other cities. In the case of Greece, it needs to find its marble, its comparative advantage.

Unfortunately, Greece is not really competitive in many global markets, including agriculture, software/IT, manufacturing, financial services, or energy. But what it does have is great weather, endless miles of beaches, and rich history, all of which combines to produce a pretty unique and enviable tourist destination. Greece needs to fashion itself as the new tourism capital of Europe. With a new, cheap drachma, it could start building new hotels, restaurants, and boutique shops, along with airports and seaports to serve the incoming tourists. It could, as Iceland has, partner with airlines to provide cheap, direct flights from the dense population centers of Europe. This would help bring an inflow of Euro into Greece, which the Greeks could then use to buy whatever goods and services from the rest of Europe that they could not produce on their own.

In short, the Greeks need to take advantage of every grain of sand and ray of sunshine they can. Without building it tourism industry to become a world class competitive advantage, Greece risks slipping into 3rd world status.

Wednesday, April 29, 2015

Why full employment matters

Its often easy to dismiss progressive chattering about "full employment" as another fuzzy liberal pipe-dream. An its even easier for neoliberal economists to define full employment as simply a number that seems "good enough" (of course, the official unemployment rate is a joke, as is the traditional definition of "good enough.)

But full employment means more than just a number. It means that our nation is reaching its best. It means that everybody who is willing and able to contribute to society and solidify some meaning in their lives can do so. A job isnt just about what goods and services you produce, although that is important. Jobs give us things to do with our minds and bodies and give us a sense of accomplishment. A good day at work can give us confidence we might not otherwise have. And even a bad day at work can serve to take our minds off of personal struggles we may be having.

Tuesday, April 14, 2015

Regulations D, Q, and modern monetary policy (wonkish)

This long post will discuss Regulations D and Q, their history, purpose and effect on the banking system. It elaborates on modern monetary policy operations and recent developments that have further removed the necessity for the anachronistic reserve requirements established in Regulation D.
Regulations D and Q were written to clearly demarcate between highly liquid transaction accounts and less liquid savings accounts/ bank CDs. Their purpose was only relevant under the gold standard. Under the gold standard, demand deposits (checking account deposits and physical currency) could be exchanged for gold at a fixed rate, whereas time deposits (savings accounts/CDs) could not. 

Therefore the banking system needed to control the flow between the percentage of the money supply that was not convertible into gold (savings/CDs/bonds) and that which was (checking/cash). Reg Q’s purpose was to allow banks only to pay interest on non-convertible time deposits as a way to incentivize customers to put their deposits into these accounts, and therefore limit the banking system’s exposure to gold convertibility risk. To further delineate time and demand accounts, Reg Q also prohibited the payment of interest on demand deposits until 2011.

Regulation D then, required banks to hold a certain percentage of central bank money (reserves or vault cash) against certain types of deposits. The classes of reservable deposits has changed over time, and now only net transaction accounts, (demand deposits/checking accounts) must be reserved against:


As an another matter, Reg Q also capped the interest rate that banks could pay on savings deposits, in order to prevent banks from “reaching for yield” (competing for lower quality (more expensive) loans which would then have been used to fund the higher rate paid to depositors. Another objective of capping interest rates on deposits was to increase bank profits by limiting the competition for deposits. Congress at the time felt that competition for deposits not only reduced bank profits by raising interest expenses, but also have might cause banks to acquire riskier assets with higher expected returns in attempts to limit the erosion of their profits.

Congress thought unpredictable movements of deposits among banking institutions in response to interest rate competition made some banks vulnerable to failure. Another related reason was that big money center banks could pay higher interest rates for deposits than smaller banks, and thus could bid deposits away from smaller regional banks. Larger banks frequently made more speculative loans, such as for buying shares in the stock market. Lawmakers believed that this competition for deposits misallocated financial resources away from productive to speculative uses.

In this way, Reg Q set a rough floor to lending quality. Reg Q’s blunt way of preventing the “race to the bottom of underwriting quality” has now largely been replaced by ability-to-repay standards from CFPB, and the capital regulation system established by the Basel negotiations that began in 1988.

Regulation D is written to limit the liquidity of savings accounts by only allowing a certain amount of monthly withdrawals from time to demand accounts. Reg D also imposes reserve requirements on depository institutions, which was intended as a tool for managing the supply and price of bank money. These requirements created a continuous demand for central bank money (reserves) above and beyond what was needed for interbank payment settlement. Therefore by creating demand, the Fed as the monopoly supplier of reserves could control the price of these reserves and therefore the profitability of bank lending. 

Before 1971 when the Federal Reserve’s own liabilities were convertible to gold, it had an incentive to restrict the amount of its reserves that backed the credit created by the banking system. So once this gold convertibility ended, the Fed slowly began to ease its reserve lending facilities, since it no longer faced any convertibility risk of its own. The 2003 amendments to Regulation A, which established the discount window Primary Credit Facility as a “no questions asked” liquidity facility were perhaps the first demonstration of this change.

Technically however, the US left the gold standard in 1933, with only dollars in foreign central banks convertible into gold during the Bretton Woods era which ended in 1971. Nevertheless, during this time and to some degree up to the present, the Federal Reserve and economics profession have not fully understood the monetary policy implications of the removal of the gold constraint.

Since the Fed both imposes reserve requirements, and requires a positive end of day balance in all Fedwire accounts, it has no choice to provide reserves to the banking system, at its target rate. These reserves can be provided through open market operations/Repos, through intraday credit through the Daylight Overdraft facility, or finally through the discount window at a penalty rate. The demand for these reserves is completely inelastic, much like a diver at the bottom of the ocean needs an air supply. Not providing reserves at any price would result in either a shortage of clearing balances or shortage of required reserves, both of which would cause banks to bid up federal funds above the FOMC’s target rate. Therefore, the Fed as the monopolist, has no choice but to provide reserves in unlimited quantities at its target rate in order to defend the payment system and ensure all reserve requirements can be met without bidding up the federal funds rate.

If banks were left on their own to obtain more reserves no amount of interbank lending would be able to create the necessary reserves. Interbank lending changes the location of the reserves but the amount of reserves in the entire banking system remains the same. For example, suppose the total reserve requirement for the banking system was $60 billion at the close of business today but only $55 billion of reserves were held by the entire banking system. Unless the Fed provides the additional $5 billion in reserves through some facility, at least one bank will fail to meet its reserve requirement. The Federal Reserve is, and can only be, the follower, not the leader when it adjusts reserve balances in the banking system. Perhaps the best example of the irrelevancy of reserve requirements is that the Fed has not changed them since April 1992, the month when I was born! However, it is important to keep in mind that the reserve requirement itself does not matter. If reserve requirements are 10% or 100%, either way the Fed must provide reserves at its target rate, as explained above.

Once Richard Nixon ended what was left of the gold standard in 1971, neither of the restrictions from Regulations D or Q became necessary. Since neither demand nor time deposits were convertible to gold (or anything else at a fixed rate) after 1971, the banking system faced no convertibility risk and therefore did not need to differentiate between deposit accounts or pay interest on time deposits to reduce such risk. Other than issues relating to funding stability, from the banks perspective checking and savings accounts became essentially the same. The regulatory atmosphere finally caught up to this post-gold standard reality in 2011 when the Federal Reserve repealed the last remaining part of Reg Q which prevented banks from paying interest on demand deposits (see side note).

While Reg D still exists, it is also less relevant than ever. The movement of much of the deposit base to money market mutual funds, and allowing banks pay interest on both checking and money market accounts, makes Reg D’s limit on time deposit withdrawals largely irrelevant. Further, over the past several decades most banks have become able to effectively avoid reserves requirements through the use of sweep accounts. These sweep accounts are set up to automatically sweep most of a banks reservable deposits (demand) into non-reservable deposits (time) at the end of each 14-day reserve maintenance period, which reduces most of a banks reservable deposits.

Sweeps surged between 1995 and 2000. All charts from the Federal Reserve.

The proliferation of sweep accounts has significantly reduced the percentage of banks required to maintain reserve balances.




Many depository institutions seek to meet most of their reserve requirements through holding vault cash. Since vault cash is necessary for the everyday business of meeting ATM/window withdrawals, banks figure they might as well use cash to meet reserve requirements as well. So what banks do (or at least did before IOR) is to meet as much of the reserve requirement through vault cash, and then adjust their reservable deposits so the RR would be met by what they already had in cash. This is the opposite of what the old fashioned, textbook version of reserve requirements would suggest.
Required reserve balances declined sharply in the 1990s as vault cash holdings rose.


Further, the trillions of excess reserves in the banking system resulting from three rounds of quantitative easing have left the banking system with enough reserves to meet even these minimal requirements for decades into the future. Much of the Federal Reserve’s own literature has supported both of these points.



All of this all dramatically changed during the financial crisis of 2008. As the financial crisis was worsening the Fed faced a conundrum. Through its various new/expanded crisis- lending facilities (discount window, TALF, Corporate paper facility, etc), the Fed was adding trillions of dollars of reserves to the banking system, but it still had an overnight interest rate target above zero. Having run out of unencumbered Treasury securities to sell off its portfolio in order to drain these added reserves and support its interest rate target, the Fed needed a new tool (during this time the Fed actually had to rely on Treasury to conduct a special purpose bond offering with the sole purpose of draining reserves, known as the Special Financing Program or SFP).

The Financial Services Regulatory Relief Act of 2006 had authorized the Federal Reserve Banks to pay interest on balances held by or on behalf of depository institutions at Reserve Banks, subject to a rulemaking by the Board of Governors, to be effective October 1, 2011. The effective date of this authority was advanced to October 1, 2008 by the Emergency Economic Stabilization Act of 2008, and a rule amending Regulation D was finalized just a week later.

So in October of 2008 the Fed gained the ability to pay interest on reserve balances, a power which it previously did not have. This allowed the Fed to establish a non-zero overnight interest rate without having to conduct any POMOs or Repos. With the floor of interest rates now solidly in place, the Fed could continuing lending emergency reserves into the banking system while simultaneously maintaining a nonzero federal funds rate. Interest on Reserves (IOR) changed the game in the federal funds market, and trading volume decreased significantly, by about 75%.

The 2008 changes to Regulation D effectively eliminated the need for reserve requirements. Since the Fed now has the ability to pay interest on reserve balances, it can “sterilize” a certain percentage of the monetary base simply by incentivizing banks to move balances out of the federal funds market and into interest bearing reserve accounts, known as “excess balances accounts”. It can also do this in a more limited fashion with its new Term Deposit Facility (neither of these facilities are available to the GSEs or FHLBs, so some trading in federal funds remains, which is why the effective federal funds rate is slightly below the 25 basis points paid on reserves). In this way, the rate paid on reserve balances serves as a floor to short term interest rates, and the rate charged for institutions that borrow reserves from the Discount Window or through overdrafts represents a ceiling on short term rates.
So with this monetary incentive in place, there is no need to require banks to hold a certain amount of reserves through regulation. Under the IOR system, no regulatory requirement is needed to create a demand for reserves (although even with no IOR banks would still need to hold reserves to meet payments).

This is the way the Bank of Canada has implemented monetary policy since 1999. Canada eliminated its reserve requirements in the 1990’s. Since then, it has set a floor for the overnight rate through the interest it pays on settlement (reserve) balances, known as Deposit Rate, and set the ceiling through the rate it charges for overnight loans (discount window), known as Bank Rate. Deposit rate and Bank rate are usually set 50 basis points apart, just like the IOR rate and Discount rate are in the US. The overnight rate therefore trades in the band between these two rates, and the Bank of Canada sets the midpoint of these two rates as its target rate. This can be expressed as: Bank Rate>Target Rate>Deposit Rate.

Concerns that implementing monetary policy by increasing the rate paid on reserves represent an increased cost to the government are unfounded. While it is true that the interest the Fed pays on reserves is subtracted from what it would otherwise remit to the Treasury, the Treasury ends up ‘paying’ either way. If the Fed were to raise interest rates by selling off part of its Treasury portfolio, as it has done in the past, then its earnings, and therefore remittances to the Treasury, would decrease by about the same amount, and the yield on new Treasury offerings would rise. (In fact, it is likely the case that banks end up earning less under the IOR scenario, since the spread earned by Primary Dealers banks acting as middlemen between Fed and Treasury operations was likely higher than the current 25 basis points paid on all reserve balances). Therefore the size of the Fed’s payments to the Treasury depend on the size of its portfolio, not on the method used to raise interest rates. Either way, the Federal Reserve’s earnings represent a tax on the economy, since the dollars that it earns and remits to the Treasury would have otherwise remained in the economy and distributed to savers, bondholders, or bank shareholders.

QE merely represent a swap of governmental assets. When the FRBNY purchases Treasury and Agency securities, is removes the Treasury/agency liability and replaces it with its own liability (reserves). Deposits merely shift from securities accounts at the Fed (saving) to reserve accounts at the Fed (checking). This is identical to moving money from a savings account to a checking account. Concerns that this rise in reserve balances could lead to inflation stem from a misunderstanding of the post gold standard banking system. Since the start of QE, many lawmakers and banking analysts have express concern that this increase in reserves will lead to an explosion in new money creation through bank lending ,that could put upward pressure on prices (needless to say, these people have been completely wrong.) However, even before QE, as described above, the Fed, as the monopolist of reserves, had no choice but to provide reserves to the banking system in unlimited quantities, at its target rate. Now, as before, the Fed can only influence the marginal cost/profitability of making a loan, not a bank’s ability to do so. Bank lending is not constrained by any quantity of reserves; it is the price of reserves that influence the marginal cost of making a loan.



When banks make loans, they are not “loaning out reserves” as is often portrayed. Reserves are simply a liability of the central bank that can only exist in central banks accounts, known as reserve accounts. Reserves cannot be lent “out”, or leave the banking system (except as withdrawals of physical currency, which is not a matter of monetary policy). In reality, banks create credit, which Reg D then requires to be backed by a certain amount of central bank money; they do not “lend out” anything. The textbook money multiplier model only applies to countries on a fixed exchange rate where the central bank itself faces a convertibility risk. In most countries with floating currencies, the money multiplier model does not apply, as the Bank of England demonstrated in this paper and video last year. Most of these countries have appropriately eliminated reserve requirements after recognizing that they are no longer necessary.

During the “bubble” of the 2000’s when ostensibly too much lending was going on, there were only a few billion of excess reserves in the banking system. Now with $2.5 trillion of excess reserves, there is arguably “not enough” lending going on. Clearly there is no correlation between quantity of reserves and lending. It’s about marginal price, not quantity.

Bank lending merely represents the creation of a new demand deposit balance for the borrower (the banks liability) and a corresponding creation of a new bank asset of equal value (the borrower’s liability). This is accomplished through simple dual-entry accounting, and done completely independently of a bank’s reserve position. Loan officers do not have to check with the CFO to see if they “have the money” to make a loan! Once the borrower pays back the loan, both the bank’s liability and the bank’s asset cease to exist, wiping out both sides of the balance sheet. Therefore, eliminating Regulation D’s reserve requirements (as was done in Canada many years ago) will have no tangible effect on bank lending, economic growth, or inflation.

In any case, the Federal Reserve cannot control the money supply, as the failed efforts of the monetarists in previous decades has demonstrated. The money multiplier is simply the ratio of the broad money supply to the monetary base (mm = M/MB). Changes in the money supply cause changes in the monetary base, not vice versa. The money multiplier is more accurately thought of as a divisor (MB = M/mm). Failure to recognize the fallacy of the money-multiplier model has led even some of the most well- respected experts astray. The inelastic nature of the demand for bank reserves leaves the Fed no control over the quantity of money. The Fed controls only the price, which has not been changed by QE or IOR, and would not be changed by eliminating reserve requirements.
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Side note: now that banks are allowed to pay interest on checking deposits, theory indicates that checking account balances at banks would rise, since they no longer represent a lost interest opportunity to the depositor. However, an increase in checking account balances also means an increase in demand deposits, which banks have to hold reserves against. Normally, an increase in reservable deposits (in absence of sweeps of course) would constitute a larger “tax” on the bank, since holding more unremunerated reserves would impose a marginal cost to the bank. However, now that the Fed pays interest on both required and excess reserves, the higher cost of holding more reserves against larger checking account balances can be mitigated.