Category Archives: Questions

What do Myanmar driving and our monetary system have in common?

21 Thursday Mar 2019

Posted by in Monetary Policy, Questions, Travel

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Both make people’s lives unintentionally difficult and complicated by having changed the system in the 1970s but continuing to insist on following the same old rules.

In 1970, Myanmar General Me Win changed the direction of traffic in the country (literally overnight) from left to right. Such a sudden decision would have been a precarious change even in the best of circumstances, but in the case of Myanmar which, having been a British colony, traffic had been on the left with a right-hand drive steering wheel, it was truly extraordinary given that all the cars continued to be with a right-hand steering wheel!

In 1971, US President Richard Nixon ended the gold standard which had been at the core of most of the world’s monetary systems for centuries. The world truly went on fiat money. That would have been a difficult task in the best of circumstances given the previous history of fiat money. In the case of US, and most other countries, it became an impossible one given that no attempt was made to upgrade the monetary system to the new reality of fiat money.

Every country we have visited so far on our journey is unique on its own, but no country in the world is so truly unique as Myanmar when it comes to driving on the road. We spent almost a month in Myanmar and honestly it took me some time to realize that we were driving on the right side of the road but also the driver is sitting on the right side of the car! Can you imagine how hard and crazy this is? I actually can, having lived in London for two decades and frequently driven to Europe. But even that is not a good comparison as I would generally drive on well-kept highways in Europe, while in Myanmar there are no real highways, all roads are single lane and quite bad by European standards. Try overtaking under these conditions in Myanmar: when the steering wheels of cars didn’t change, people were left with relying on honks and passenger guidance when merging into a lane.

Something similar happened with our monetary system: in 1971 we finally, and for good, threw off the gold shackles but we did not change the gold standard accounting (CB reserves vs. government bonds) and continued to impose imaginary limits on government finances and money supply in general. This is as backward, inconvenient and dangerous as a right-hand drive on the right side of the road.

I started paying attention to this monetary inconsistency only after GFC’08 when it became obvious that there is something ‘not right’ with our money supply: the way the Fed was conducting QE, the way inflation did not budge, and the way no one batted an eyelid when the $700bn financial rescue plan was announced. Then I discovered Mosler, Wray and the rest of the original MMT crew. Finally, I brushed up on financial history going well beyond the Great Depression, when ‘MMT’ was last popular, to Knapp and even beyond (“Debt: the first 5,000 years”). But what convinced me most that our monetary transmission mechanism is far from optimal (just like in Myanmar, I had to spend some time on its roads to even notice the peculiarity) was that I was intimately involved in the plumbing of the financial system by trading and having exposure in the short end of the money markets, especially in the years following GFC’08.

What is extraordinary for me in both cases is that people don’t seem to be bothered and despite the obvious difficulties prefer to just get on with the existing status quo. Speaking to locals in Myanmar, there is neither appetite to change back to the previous driving system, nor to start importing left-hand driving wheel cars (even though some people have mentioned a draft law that would have a cut-off point after which only left-hand drive wheel cars would be allowed to be imported). In the case of gold-standard-monetary-system-not-fitted-to-a-fiat-world, the people in power (central bankers, prominent economists) have ridiculed any attempts to think of possible improvements.

Is Boeing giving too much money back to shareholders?

18 Monday Mar 2019

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Has Boeing invested enough in R&D? Could investing more instead of returning money to shareholders in the form of share buybacks and dividends have prevented the faulty automated system which supposedly was the cause of the two most recent fatal crashes?

  • Boeing’s share price has risen more than 250% over the last 5 years. The DJI, of which Boeing is a part of, has risen about 60%; the S&P Index has risen about 50% during that period.
  • Boeing has bought back a total of $39Bn of shares over the last 5 years which is actually just about half of the authorized amount. The 2018 share buyback payout ratio was about 76%. The share buyback has increased by 50% over this period, and at the moment it is one of the largest among US companies.
  • As a result of the share buybacks, Boeing’s share count has been reduced from 767m in 2013 to 586m in 2018, or by about 24%.
  • Over the same period Boeing has spent about $17Bn on R&D, about half the amount spent on buybacks; R&D spending has been flat in the last 5 years.
  • Top-line revenue growth over the last 5 years is about 3% per annum which fades in comparison to share price growth, or EPS growth (see below).
  • Bottom-line EPS annual growth rate, on the other hand, is about 24%. There is no doubt that this is a consequence of decreased share count (see above) simply by logical deduction. However, it could also be as a result of reduced costs (of which employment still is the largest, see below). Either way, both causes can be seen as a temporary phenomenon and not good for the company’s long-term prospects.
  • Boeing has reduced payroll by about 10% over the last 5 years, despite total US full-time employment rising by 10% over the same period.
  • Boeing has increased its dividend by 325% over the last six years. For 2018, its dividend payout ratio was 39%, which makes the total payout ratio stand at 115%, i.e. Boeing is spending more than 100% of its earnings on shareholders payouts. This is financed pretty much all by rising FCF rather than new debt.
  • Nothing wrong with giving some FCF back to investors IF: 1) that does not jeopardize the company’s future profitability, which would be determined more by top-line rather than bottom-line growth – there is a limit how much costs can be cut; 2) that means, unintentionally, producing a defective product which not only cuts company’s profitability or causes, in extreme cases, actual physical damage to consumers. In both cases, the verdict on Boeing is still out.

To all the people who think share buybacks are the best way to utilize company’s resources, that they do not affect the company’s share price, that they do not reduce the share count and have no bearing on employment, Boeing is not your best example.

Is Japan doing that bad?

16 Wednesday May 2018

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Latest GDP numbers out of Japan came out overnight and though the decline in GDP was expected, it was worse (-0.1% vs -0.6% actual). But is this really a surprise given the continuous decline in the Japanese population – deaths outnumber births now by more than 1,000 per day?

  • The growth rate of Japan’s population started declining in earnest in the mid-1970s, but it turned negative only in 2009. Absent massive rises in productivity, it is natural for GDP growth rate to decline as well in line with the decline in population growth.
  • Still, Japan’s GDP growth rate has been consistently above the growth rate of its population (another way of saying GDP per capita rises) except for a brief period post the 2008 financial crisis. Nevertheless, the average GDP growth rate since 2009 is still above the average growth rate of the population (0.6% vs -0.1%, respectively).

What does this mean? Positive labor productivity growth rate.

  • Since the 2008 financial crisis, Japan’s annual GDP per capita growth rate averaged the same as US’. Even since the 1990s, when Japan’s supposed stagnation started, its GDP per capita was on average just 35bps lower than that in the US.

  • GDP per capita growth can be broken by growth in labor productivity (GDP per hour worked) and changes in labor utilisation. Measured by GDP per hour worked, Japan surpassed USA in 1989. But measured by labor productivity growth, it has outperformed the US since the 1970s at least.

  • High labor productivity can come from many things (greater use of capital, low labor utilisation, innovation). In general, Japan tends to have a lower labor utilisation rate than US. That could mean more automation/ less employment of low productivity workers.

  • Perhaps that is why, Japan also tends to have a lower labor compensation (per hour worked) growth rate than US. However, in 2016, for the first time, that changed.

Bottom line is as long as population continues to decline, GDP should also be expected to decline given also lackluster productivity growth. However, as long as productivity growth is positive, GDP rate of decline should stay above population rate of decline. It could be better, but there is nothing bad about that either.

Is the effect of demography on inflation fading?

10 Thursday May 2018

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Good paper by M. Juselius and E. Takats on “The enduring link between demography and inflation” pointing to the fact that:

  • an increase in the share of the dependent population is generally associated with higher inflation; and
  • aging is set to increase the share of dependents, reversing a previous trend.

Is inflation then set to burst higher? It depends.

First, even though the global dependency ratio is rising, its level is not the same for each country. For example, China’s current dependency ratio at 40 is 58% of Japan’s at 68. US dependency ratio is forecast to rise the least; in fact, in the mid-2030s, it is forecast to start declining again.

Second, a lower dependency ratio, even though a rising one, should in theory cause less upward pressure on inflation. By that measure, US inflation may rise but would probably rise less than UK’s and EU’s; in fact, by 2050, with US dependency ratio the lowest among these major countries, one would expect US inflation to be the most subdued.

Third, Japan’s dependency ratio has been rising pretty much since the great crash in 1990, and, in 2007, it surpassed these other countries’ dependency ratios, while this whole time has coincided with a period of consistent deflation there: obviously there are other, presumably, much stronger determinants of inflation.

Fourth, and to the latter point, with the advance of technology, labor’s role in the production function is becoming less important. Does that mean that demography’s role in influencing inflation is also fading?

What does investment-led growth even mean?

27 Monday Nov 2017

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It does not matter how we spin it and define it, economic growth is about production and consumption chasing each’s other tail in a circle. We can argue what comes first but reality is that we need both.

A few years ago, Noah Smith wrote a blog post with a similar sounding title but focusing on consumption.

Nowadays, it seems fashionable to talk about innovation in technology and increasing productivity so the latest epiphany when it comes to ways to boost economic growth is to focus on investment (with the buzz words of driverless cars, AI, blockchain, etc.).

In other words, we have given up on trying to do anything about the demand side of the economy (purchasing power down because wages pressured by automation and globalization) so let’s go back to trying to increase the supply (and hope that it will create its own demand?). Sadly, Say’s Law does not work in the modern fiat-based economy (maybe it did work in a barter economy).

So, increasing investments, will it push up GDP growth?

Yes, of course. GDP(Y) = investment(I) + consumption(C) + government spending(G) + net exports(NX). If we increase I, Y will go up.

But aren’t we already operating way below capacity in the developed world? What’s the point of creating even more capacity. The point is that at t(0), if I goes up, Y goes up (and inflation probably goes down, but who cares, right?).

But let’s say we weren’t operating below capacity. Doesn’t this investment at some point need to be ‘consumed’? How is it going to be consumed if there is no purchasing power?

Or maybe the plan is to ‘export our investment’ so that some other country can consume it. Well, I guess it is possible, but the stuff we are good at (financial services, defense, education) we are already exporting. There are a lot more things we are good at but they are either in the digital sphere where the marginal cost of production and, especially distribution, is zero and there is not much value-added, or we do not want to export it (really high-tech stuff).

I think the sad reality is:

We have exhausted all other options in the above equation.

C: Not that consumption-led growth does not work per se, but that it does not work with borrowed money. It does work, however, if people have the income to consume.

G: No one has the appetite for more government spending (even though some people, when they talk about investment-led growth, do include the government there)

NX: It’s not like there are many other countries out there that are eager/have the means to consume.

So, yes, increasing I is the next logical step. And it could work as long as that is accompanied by a rise in purchasing power which eventually gets transformed to a rise in aggregate demand which leads to increased consumption. Or something like this: I rises in t(0) -> Y rises in t(0) which leads to a rise in C(t+1) and a corresponding rise in Y(t+1). A virtuous cycle we could create indeed.

But if I does not result in a rise in purchasing power, i.e. if we invest in increasing production through automation, then it is a dead end. Which is why all these corporates are sitting on their cash and buying back their share and not investing.

In an environment when inflation is close to zero and we are operating way below capacity, it sounds strange to me that we are going to focus on investment which will only increase capacity, instead of figuring out how to prop up consumption without incurring more personal debt.

It is a totally different argument whether we need consumption at all, or rather whether even if we give people money to consume they will (I bet the millennials are much less likely to consume regardless of their income). Which raises the issue of whether we really need additional GDP, whether that should be our focus etc.

My answer is as long as we have a debt-based economy, we are hooked on GDP. All this talk about fancy other stuff to measure our wellbeing is great but it does not cut it that somebody has to service that debt. Of course, there are alternatives but they must be accompanied by some sort of a debt jubilee.

What is the optimal central bank balance sheet size?

16 Thursday Nov 2017

Posted by in Debt, Monetary Policy, Questions

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Answer: Depends on the size of the overall financial system balance sheet and whether it is deleveraging/leveraging.

This is a follow up on a previous post addressing the rationale for a continued increase of the major central banks’ balance sheet barring a sudden rise in the ‘private’ banks’ balance sheets.

Summary: We have been used to a small and relatively stable central bank balance sheet because before the 2008 financial crisis, the banking system balance sheet had been steadily growing. However, post the crisis, the banking system started deleveraging across the developed world. To avoid a continuation of the financial crisis, the central banks there had no choice but to leverage, i.e. increase their balance sheet.

Going forward, the size of the central bank balance sheet will be very much determined by what happens with the banking system balance sheet as a whole: if banks continue with the deleveraging, something which is more than likely given the plethora of financial regulations (Dodd-Frank, Basel III, MIFID2, FATCA, AMLD, AIFMD, CRS, etc.), the central bank may have to continue to expand its balance sheet or face another financial crisis.

Background

Since the 2008 financial crisis, to most economic observers, central banks have been increasing their balance sheets in order to facilitate easier economic conditions having exhausted their conventional means to do so. There is a strong debate among economists, investors and market practitioners, in general, about the effectiveness of such policies. I argue that the direct economic issues (growth, inflation) may have been of secondary importance to the reasoning behind the increased central bank balance sheets.

Central bankers’ primary objective may have been financial stability, including maintaining a stable rate of growth of the country’s total financial balance sheet. In that sense, some central banks’ balance sheet may need to grow even larger if the ‘private’ banking sector continues to deleverage.

On one hand, central banks’ balance sheets are unique in the sense that they act as the lender of last resort: they control, and, to a certain extent, regulate the money supply. That’s the conventional view of central banks. On the other hand, they are an integral part of the country’s financial sector, and, therefore, cannot be viewed in isolation.

The ‘private’ and central banks’ balance sheets are indeed linked together. We have been used to the former generally rising, especially so after the great financialization of the economy beginning in the 1980s. Therefore, we have taken it for granted that the central bank needs to just ‘sit back and relax’: there was no need for it to do any heavy lifting, i.e. the central bank’s balance sheet did not need to rise relative to GDP or to the whole financial sector’s balance sheet.

Since 2008, however, we have seen the private banking system heavily deleveraging in the US and EU. In Japan, the deleveraging actually started in the mid-1990s when the ‘private’ banking system’s balance sheet started shrinking relative to GDP. In order to maintain financial stability, the central banks in these respective countries needed to start to increase their balance sheet at a much faster pace than GDP and, more importantly, than the rate of deleveraging of the ‘private’ banking sector.

Japan

Even though it started properly leveraging (QE) only in the early 2000s, the Bank of Japan (BOJ)’s balance sheet started growing relative to GDP at the same time the domestic commercial banks’ balance sheet started deleveraging in the mid-1990s (see the chart on the right hand-side of the panel below). Nevertheless, the total financial system balance sheet (BOJ + the commercial banks) continued to decline between 1995 and 2007 (see the chart on the left-hand side of the panel below). The BOJ should have expanded its balance sheet much more back then.

Ironically, it was after the 2008 GFC that the domestic commercial banks’ balance sheet in Japan started growing again in line with also the BOJ’s balance sheet. As a result, the total financial system balance sheet also started growing. However, it took until 2016 for it to reach its previous peak from the mid-1990s. That was mostly thanks to the BOJ heavily increasing its balance sheet by starting to buy also private assets – corporate bonds, REITs, equities.

EU

Financial institutions in the Euro-area started deleveraging after the sovereign crisis in 2012 and since then have shed about 4Tn EUR in assets (Left-panel chart below). The European Central Bank’s (ECB) balance sheet, on the other hand, has increased by about 3Tn since the 2008 financial crisis with the majority of the increase happening after 2014 (Right-panel chart below).

Indeed, between 2011 and 2014, both the banking system’s and ECB’s balance sheets had been decreasing relative to EU-area GDP – a fact which substantially contributed to the prolonged negative effect of the sovereign crisis and kept European assets underperforming (Right-panel chart below). Since 2014, however, while the banking system balance sheets continued to decrease, the ECB balance sheet started to rise relative to GDP.

As a result of that, the total balance sheet (ECB + financial institutions) has started to stabilize at these levels (Left-panel chart above). Nevertheless, it seems that the ECB is indeed repeating the BOJ error of taking its time to raise its balance sheet to support the deleveraging happening in the banking system. If that deleveraging continues, as is more likely than not on the back of continued regulation (Dodd-Frank, Basel III) and the pressure form fintech and now cryptocurrencies, the ECB will most likely also have to massively increase its purchases by adding private assets to the list, just like BOJ.

US

US total banking system assets (Fed + financial institutions) are unchanged since the 2008 financial crisis (Left-panel chart below). Even though, the financial system has indeed deleveraged by the order of $3Tn (Right-panel chart below), the Fed has made up by leveraging its balance sheet by about the same amount. In fact, this is the first time since WW2 when banks in the US have deleveraged.

However, most of the liquidity in the system since the mid-1990s has been generated in the shadow banking system (see here, for example). Therefore, for the US, I have compared the central bank’s balance sheet to total domestic liquidity (Charts below).

Total liquidity relative to GDP is still decreasing despite the efforts of the Fed to the contrary (Left-panel chart above). Except for the period between WW2 and 1957, there was only one other period when total domestic liquidity was decreasing – during the Savings and Loan crisis in the late 1980s.

Fed’s liquidity is now starting to slow down as well. This is a big risk if the banking system also continues to deleverage (Right-panel chart above).

Conclusion

BOJ, ECB, Fed balance sheets are much bigger relative to GDP and relative to where they were before the crisis on absolute levels, but relative to the total balance sheet of the financial system they are still quite small. If the ‘private’ banks continue to deleverage, the central banks’ share of the total balance sheet will continue to naturally rise even if they do not increase their balance sheet. The overall financial system will shrink as a result. However, the risk to the financial system is much bigger if the central banks also deleverage at the same time.

Why US equities keep outperforming?

07 Saturday Oct 2017

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A lot has been written lately about the outperformance of US stocks over European stocks. Here is a good summary.

I would add two other things to the list of possible reasons for this outperformance.

Corporate share buybacks

US corporate stock buybacks are a feature in US equities to a much larger extent than European corporate stock buybacks. For example, US corporates were given a “green light” to buy their own shares when Rule 10b-18 was introduced in 1982. The S&P Index started outperforming the DAX in the mid-1980s (Chart below, both of them indexed to 100 in 1959).

Source: Bloomberg, author’s calculations

As US buybacks increased, the outperformance became more obvious (Chart below).

Source: Bloomberg, author’s calculations

Intangible assets

A second reason for the outperformance of US stocks could be the higher % of intangible assets in US indices (Charts below).

Source: “Intangible Asset Market Value Study” by Cate M. Elsen and Nick Hill

Historically, the combined value of a company’s physical assets should equal its market value. But we know that this Tobin’s Q ratio has become a bad predictor of the stock market. Why? Because intangibles have replaced physical assets as the main factor of production. We cannot see the intangibles on companies’ balance sheets but there are ways to guess their worth (look at investments/expenditures on the income statement). According to Simcha Barkai from the University of Chicago, intangibles are worth $48Tn just in the US (that’s more than the physical value of all companies’ assets)!

What if central banks gave the QE money to the people?

03 Tuesday Oct 2017

Posted by in blockchain, Debt, Monetary Policy, Questions, UBI

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I would not be blindfolded by the fact that the US is trying to go back to ‘normal’ with the Fed on a rate-raising spree. ‘Normal’ changed a long time before 2008. You cannot go back to ‘normal’ with a broken monetary transmission mechanism. We can create all the money in the world but if it goes in the hands of the few, if it is subsequently ‘hoarded’ and if it cannot  reach the end consumer because Work≠Job≠Income (whether that is because of technology, globalization or whatever) or because the credit channel is closed (the end of the private debt super-cycle in 2008), the economy is not going to go anywhere. And if there is little demand because there are not enough mediums of exchange, aka money, circulating in the economy, optimizing production is a waste of time and resources.

Instead of focusing on going back to a ‘normal’ interest rate policy, a forward-looking central bank would be looking into the opportunity presented by the rise of the blockchain technology and the subsequent spread of digital cryptocurrencies. The latter are a direct response to the broken down monetary transmission mechanism: if the traditional mediums of exchange do not circulate in the economy, people are devising their own ways of exchanging goods and services.

The interest-rate cycle is something of the past now. If the financial crisis of 2008 did not make it obvious, perhaps, we have to wait for the next one, which would be here like clockwork as policy makers embark on the policy of ‘normalization’. But there is some hope that some central banks are looking into ways to introduce a digital currency of their own and opening their balance sheet to the public at large.

Back of the envelope calculation shows that if the money spent on buying financial  assets by the central banks of UK, US and Japan, was instead disbursed directly to the people, working wages would have risen substantially.

Between 2008 and 2016, central banks’ balance sheets have risen by 360% in the UK, 99% in the US and 280% in Japan.

Source: Bank of England, US Federal Reserve, Bank of Japan

At the same time, over this period, nominal wages have risen by only 14.8% in the UK, 18.4% in the US and actually fallen by 2.9% in Japan! In 2016, the average annual wage in the UK was GBP 34,142, in the US – USD 60,154 and in Japan – Yen 4,425,380.

Source: OECD

Japan is peculiar also because its working age population declined by 7.4%, while US’ and UK’s rose by 4.5% and 2.7%, respectively, during this period.

Source: OECD

I took the actual change in central bank balance sheets and divided it over the average working age population between 2008 and 2016. If this money could have been disbursed directly to the people, workers would have received a lump sum of GBP8,574, USD10,997, Yen4,430,424 over the period.

Let’s imagine that this lump sum was disbursed to the working age population at the end of 2016. Compared to 2008, their wages in 2016 would then have been higher by 44% (UK), 40% (US), 98% (Japan)!

If wages could indeed ‘miraculously’ rise by almost half in the UK and US and almost double in Japan over this 8 year period, what are the chances that we would still be stuck around 2% inflation in the US and UK and around 0% in Japan? Where would GDP be?

This is a very simple exercise. Undoubtedly real life is much more complicated that this and it is rarely black and white. Moreover, this would have been a lump sum disbursement, a one-off boost to income, and not a permanent rise in wages. Consumer behavior in this case, Ricardian equivalence, etc., would have been very different from a situation with a permanent rise in wages.

However, instead of patting ourselves on the back that things could have been much worse had the central banks not backstopped the financial system by buying financial  assets, can we not also think how they could  have also been much better if we found a better use for the money miraculously created out of thin air? If we could create money out of thin air to boost financial asset prices, is it really not possible to devise a way whereby the consumer also gets a permanent rise in income? Can we have an adult conversation about the effects of such an experiment without resorting to the taboos of the past? Can we include people other than economists in this conversation?

The free market may be the best and most efficient optimization model available so far to us, but what if we are optimizing the wrong variable?

What is the role of surplus capital?

28 Thursday Sep 2017

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Source: Z1 Flow of Funds, US Federal Reserve/Click to enlarge

“For an individual agent, additional income is necessarily accumulated in financial or real assets. The income not spent (the individual’s “saving”), which is initially received in the form of additional settlement medium, is allocated across asset classes. But for the economy as a whole this is obviously not true. The allocation of savings simply represents a gross transfer of assets across individuals: the increase in deposits of income receivers is matched by the decline in deposits of those that pay that income out. It is only when the additional income is supported by issuance of financial claims (eg credit or shares) that financial assets and liabilities are created. By the same token, the popular and powerful image that additional saving bids up financial asset prices (and hence depresses yields and interest rates) because it “has to be allocated somewhere” is misleading. There is no such thing as a “wall of saving” in the aggregate. Saving is not a wall, but a “hole” in aggregate spending.” BIS Working Paper 346

  • There are $225Tn of US financial assets in terms of market value (Chart above).
  • Financial assets growth started to surpass GDP growth in the early 1980s as the financialization of the US economy began. For example, for 40 years between 1945 and 1985, the ratio of financial assets to GDP varied between 5x and 6x. After 1985, the ratio started moving higher and higher and currently stands at record 12x!

Source: Z1 Flow of Funds, US Federal Reserve

  • In terms of ownership, financial assets are split among three major sectors: Domestic Non-Financial, Domestic Financial and Rest of the World.
  • The Domestic Financial Sector started gathering more and more financial assets relative to the Domestic Non-Financial Sector in the early 1990s. But it is really foreigners who began heavily investing in the US as trade flows picked up in the late 1990s and strong globalization trends emerged.

Source: Z1 Flow of Funds, US Federal Reserve/Click to enlarge

  • US households’ direct ownership of financial assets has gradually decreased since 1945 in line with the financialization of the US economy. As absolute savings increased, the financial industry expanded to meet households demand for new products in which to invest them. After the 1980s, the financial industry not only was creating new products but also started investing on behalf of households.

Source: Z1 Flow of Funds, US Federal Reserve

  • Savings are a dead weight on the real economy as they drain funds away from it. If instead they were invested in real projects, arguably, employment and economic growth could have been higher. At the moment, it is the financial sector, primarily, which benefits from this surplus capital.
  • As this surplus capital gets diverted into savings, new money must be created to serve the real economy. This new money gets created as debt. This has generally been a more efficient method of  money creation than most other ones in the past as it matches closely economic activity.
  • However, as the debt stock increases mathematically due to positive interest rates, this efficiency decreases. In addition, not only new money must be created to serve the real economy but also to pay back the old debt.
  • The financial sector gets a cut on both the asset side of the balance sheet (managing the surplus capital) and on the liability side (creating the debt).
  • Looking at the US economy from this sectoral balance point of view, we should be also asking ourselves questions about the role of this surplus capital.
  • For example, what is the need for government bonds in a fiat monetary regime? Are they ‘created’ to fund US government budget deficits, for example, or to meet the demand for positively yielding (protection from inflation) and safe (protection from default) assets as the surplus capital increases?
  • Given that companies generally prefer to fund themselves using internal capital, what is the role of the stock market especially when there is also surplus corporate capital?
  • How far can we go monetizing the real world to create enough financial assets to meet the demand of the increasing capital surplus globally?
  • In the increasingly digital world where the marginal cost of production is zero and in the old industrial world where the marginal cost of production is dropping fast because of the advances of technology, how much surplus capital in aggregate do we need?
  • Do we have so much surplus capital because our income distribution model is broken?

…

Who owns US Treasuries?

21 Thursday Sep 2017

Posted by in Debt, Questions

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Source: Z1 Flow of Funds, US Federal Reserve

2016

  • The biggest owner of US Treasuries (UST) are foreigners at 37.6% of total. Relative to other holders, their ownership actually peaked in 2008 at 44.2% and they have been net seller in the last two years.
  • The second biggest owner of UST is the Fed at 15.4%. If we add state and local governments to it, the government, as a whole owns, 20.6% of UST.
  • In the domestic sector, pension funds own the most at 14.5%, followed by mutual funds at 11% and households at 8.8%.

Over the years

Source: Z1 Flow of Funds, US Federal Reserve

  • The ownership of UST has changed significantly over the years. For example, at the start of the data in 1945, the financial sector (banks, broker-dealers, etc.) owned 41.9% of the total; in 2016 that had fallen down to 4.8%.
  • Households, the corporate sector and insurance companies have also substantially reduced their UST holdings over the years.
  • Mutual funds and pension funds, on the other hand, have increased them.
  • The elephant in the room, however, is the foreign sector, which in 1945 was the second smallest owner of UST (after mutual funds) at 1%. There was a big jump in foreign ownership in the 1970s and then starting in the mid-1990s.

T-Bills vs long dated US government securities

Source: Z1 Flow of Funds, US Federal Reserve

  • Majority of US government debt has historically been in long-dated instruments.
  • However, in the mid-1970s, there were about as many T-Bills as long-dated government paper. Nevertheless, over the last couple of years, the issuance of T-bills has declined to all-time low.