30 Nov 2012

David Beckworth vs. His Critics on the Market for Apples

Market Monetarism 34 Comments

David Beckworth (here and here) is taking on the hard-money enthusiasts by challenging one of their central claims. David emailed me about this–and by the way he has a good sense of humor–so I’m pretty sure he wants me to rip him. Kind of like when Terry Gross had Don Rickles as a guest on “Fresh Air,” and she begged him to insult her. Okay David you asked for it; I will treat you like Scott Sumner, which I gather is your goal in life…

Let me focus on a subset of the arguments in this dispute. For brevity, I will boil them down into two representative statements by the generic Critic and then Beckworth’s reply (the words of course being mine).

CRITIC: Man I can’t believe how nakedly the Fed is propping up the apple market! Apples are in a bubble; their price would collapse if the Fed weren’t buying so many apples. In fact, last year the Fed bought 100% of every apple produced!

BECKWORTH: What are you talking about? The fact that the Fed bought 100% of every apple produced last year, has nothing to do with whether the Fed is “supporting the apple market” as you claim. Rather, let’s look at the real price of apples. They are at historic highs. If in fact the Fed were propping up the apple market as you claim, then why would apple prices be higher than they were before? You can’t explain that.

Another major problem with your conspiracy view: Last year the Fed began specifically targeting Macintosh apples, and it stopped buying Golden Delicious. Yet the apple growers stopped planting Golden Delicious, and switched to planting record amounts of Macintosh. If the Fed were really acting to subsidize the apple growers, then wouldn’t the two be acting in concert? Yet instead, you’ve got the Fed buying massive amounts of Macintosh apples, and the growers planting record amounts of Macintosh, rather than Golden Delicious. Your theory just doesn’t fit the facts, man.

In fact, it’s not merely that I disagree with you. Your views are so at odds with the data, that I have to stop having this conversation.

Now, to be clear, I made a few substitutions in the above. I wanted us to forget we were talking about monetary policy, because for some reason market monetarists seem to think the laws of economics change all of a sudden in this realm. Can we all agree that the hypothetical Beckworth above is making no sense at all?

OK, if so, change “apple” to “Treasury,” “100%” to “77%,” and “Macintosh” to “long-term Treasuries.” I have read his stuff a few times, and I’m pretty sure the above is a fair summary of some of his arguments. Not all of his arguments, but some.

34 Responses to “David Beckworth vs. His Critics on the Market for Apples”

  1. Jonathan M.F. Catalán says:

    I get the point this post is making: how can you say that buying 77-percent of a year’s worth of long-term treasuries has no impact on treasury yields? I think Beckworth’s point has more to do with total debt, rather than one year’s deficit, but your case is still valid: no matter how much total debt is privately held, that 77-percent of one year’s debt was purchased by the Fed still has to be significant.

    Nevertheless, his point about the demand for safe assets is relevant. The 2007–09 crisis is largely about the collapse in value of what were perceived as safe, information insensitive assets. In lieu of privately produced safe assets, it makes sense for firms and banks to instead buy U.S. Treasuries (especially as a means of reviving short-term credit markets). I think low interest rates on U.S. Treasuries really does reflect this. This doesn’t make the Fed irrelevant (without the Fed [or another de facto public money issuer], would treasury yields still be as low? probably not, because there’s no implicit guarantee), but it does suggest that low treasury yields are a product of various interacting forces.

    What I find interesting is the side comment made by Beckworth that the intentions behind Operation Twist and the Treasury contradict each other; the former wants more short-term debt issued and the latter wants more long-term debt issued. First, given that debt is a serious issue that is taken seriously even by well-known mainstream economists (i.e. Reinhart and Rogoff), the Treasury is following good advice to lengthen the maturity of debt (avoiding problems of having to constantly rollover large amounts of short-term debt). It seems crazy that the Fed wants to compromise this by pushing private parties to buy short-term debt. Second, isn’t this all in favor of those Beckworth is criticizing? The Fed wants more short-term debt, so it’s buying long-term debt to crowd out private investors, and the government continues to issue mostly long-term debt.

    I don’t find Beckworth’s point on inflation all too persuasive. The Fed buys a lot of its treasuries from private parties, like banks. Alternatively, the government might use money issued by the Fed in return for its bonds to repay private bond holders. All this money goes back to banks that aren’t lending, so it makes sense that it doesn’t circulate. This doesn’t mean that the Fed isn’t buying larger amounts of government debt; it means there’s more to inflation than just the Fed buying U.S. treasuries. But, I’d also say that true debt monetization isn’t just having the Fed buy U.S. treasuries, but outright transferring money, without receiving a debt-based asset in return, to the government to pay for expenditures.

    • Matt Tanous says:

      “Nevertheless, his point about the demand for safe assets is relevant.”

      Without the Fed, the demand for those safe assets would be far lower than is reported. (77% less, for instance.) If the government is buying all the solar panels, of what sense does it make to point to the demand for solar panels as indicative of anything?

      ” In lieu of privately produced safe assets, it makes sense for firms and banks to instead buy U.S. Treasuries”

      Makes far more sense to buy precious metals or short stock, if things are so bad. Makes more sense to buy precious metals even if they aren’t. Under the current market, short-term CDs are better than Treasuries – makes more sense for firms to go for those. Basically, there is no lack of market-provided “safe” assets.

      “I’d also say that true debt monetization isn’t just having the Fed buy U.S. treasuries, but outright transferring money, without receiving a debt-based asset in return, to the government to pay for expenditures.”

      Strongly disagree. Before, you had nothing, and now you have the government spending money that didn’t previously exist. What you are describing cannot be debt monetization – there is no debt involved. That’s just straight up printing money.

      • Jonathan M.F. Catalán says:

        Matt,

        Starting from the bottom,you’re right. What I described isn’t debt monetization. But, neither is Fed purchasing of U.S. Treasuries. My intended point, reformulated: debt monetization is money creation to pay for debt. When the Fed purchases treasuries, that debt is still owed.

        If the government is buying all the solar panels, of what sense does it make to point to the demand for solar panels as indicative of anything?

        It could just be the Fed is crowding out private purchases of long-term treasuries. It’s useful to look at private demand between 2007 and 2011, noting that private demand for U.S. treasuries has been high during the past four years or so. It doesn’t make more sense to buy precious metals and related commodities, because these assets tend to be volatile. They don’t enjoy the same status as U.S. treasuries as stable, safe assets. U.S. treasuries also tend to be relatively liquid (thus the notion that during depressions cash and treasuries become near substitutes).

        • Matt Tanous says:

          “My intended point, reformulated: debt monetization is money creation to pay for debt. When the Fed purchases treasuries, that debt is still owed.”

          Except the government issues Treasuries mainly to pay off or “refresh” debt by retiring older bonds. So the Fed buying Treasuries is to pay off other Treasuries.

          “It could just be the Fed is crowding out private purchases of long-term treasuries.”

          A counter-factual that can’t be proven.

          “It’s useful to look at private demand between 2007 and 2011, noting that private demand for U.S. treasuries has been high during the past four years or so.”

          Perhaps. Except, much of the demand through this time was the Fed, too. Stuff like this: http://www.bloomberg.com/news/2010-11-03/federal-reserve-to-buy-additional-600-billion-of-securities-to-aid-growth.html

          Or this: http://www.zerohedge.com/article/federal-reserve-accounts-50-q2-treasury-purchases

          The 77% number is all that unique – the number of Treasuries bought by the Fed has been high since the crash.

          “It doesn’t make more sense to buy precious metals and related commodities, because these assets tend to be volatile. They don’t enjoy the same status as U.S. treasuries as stable, safe assets.”

          My point was more a hypothetical that if the entire economy was crashing so bad that there were no private “safe bets”, then Treasuries wouldn’t be so safe either.

          Also, precious metals aren’t volatile – the dollar is. It’s pretty much all monetary-side issues there.

          • Jonathan M.F. Catalán says:

            Except the government issues Treasuries mainly to pay off or “refresh” debt by retiring older bonds. So the Fed buying Treasuries is to pay off other Treasuries.

            This doesn’t change the fact that there’s no net decrease in debt owed due to Fed purchases of T-bills. It just changes who owns the debt.

            Quick comments on your other responses:

            1.Whether the “counter factual” can or cannot be proven doesn’t make it irrelevant.

            2. As of now, the Fed still owns <15% of all T-bills. This is a main part of Beckworth's point.

            3. I don't understand where you're getting the idea that Treasuries aren't safe. That a financial crash caused a collapse in the value of what were once considered safe assets doesn't mean this also includes treasuries.

            Regarding your point on precious metals, we'll have to agree to disagree. I'm not convinced that the price of precious metals is entirely related monetary inflation; it doesn't explain why other prices haven't followed the movement of precious metal. I do think that a lot of people do consider precious metals safe, or even a hedge against inflation (although I think they're wrong), which explains why the prices of these kinds of commodities have grown since the recession, but these aren't the type of assets that banks and/or firms are really interested in.

            • Matt Tanous says:

              “This doesn’t change the fact that there’s no net decrease in debt owed due to Fed purchases of T-bills. It just changes who owns the debt.”

              Monetizing the debt doesn’t increase the debt owed. The whole purpose of it is to use the debt as a vehicle for monetary inflation.

              “Whether the “counter factual” can or cannot be proven doesn’t make it irrelevant.”

              No, but certainly confounds prediction based on the idea, and it utterly refutes empirical economics, once again, as a demonstration that anyone can claim anything about the economy that may or may not be true.

              “As of now, the Fed still owns <15% of all T-bills. This is a main part of Beckworth's point."

              The market does not depend on total supply, but total supply offered for sale at the given prices.

              "I don't understand where you're getting the idea that Treasuries aren't safe. That a financial crash caused a collapse in the value of what were once considered safe assets doesn't mean this also includes treasuries."

              If the economy is crashing in such a way as to render all private investment "unsafe", then there will not be much tax revenue for Treasuries to be repaid with. Thus, they can only be repaid with inflationary money printing.

              The economy hasn't crashed in this manner, and I don't even think it *can*. Which is why I contend that there will always be "safe" private investments available to a large degree.

              "I'm not convinced that the price of precious metals is entirely related monetary inflation; it doesn't explain why other prices haven't followed the movement of precious metal."

              There are two factors. Actual inflation, which rises the price demanded by suppliers, and expectations of it, which cause demands in fluctuation. And, I suppose, not *all* of it is monetary, despite my previous hyperbole – there is some (relatively small) industrial and decorative demand fluctuation.

  2. Transformer says:

    I don’t think it works to ‘”change “apple” to “Treasury’. Treasuries bear interest and apples don’t.

    My interpretation of Beckworth’s point is that by swapping treasuries for money then the value of money would fall, and assets with nominal interest rates would be pushed down in value as people wanted higher real interest rates to compensate for the ensuing inflation expectation. The fact that this isn’t happening is an indication that the debt is not being monetized according to Beckworth.

    None of this would be valid if the fed bought apples instead of treasuries.

    • Bob Murphy says:

      I don’t think it works to ‘”change “apple” to “Treasury’. Treasuries bear interest and apples don’t.

      Also, apples have seeds. Clearly supply and demand don’t work the same.

      • Bob Murphy says:

        Also, Treasury yields are pretty close to zero, for shorter maturities. So do short-term Treasuries behave like apples?

        • Transformer says:

          No. Inflation expectations would likely drive the price of apples up and of short-term treasuries down.

          • Bob Murphy says:

            OK so your statement that bonds yield interest and therefore don’t behave like apples…?

            • Transformer says:

              If the govt buys apples for newly created money then the price of apples goes up because there will less apples for everyone else and also more money chasing them.

              If the govt buys bonds (bearing a nominal interest rate) for newly created money to such an extent that people think inflation will go up by 5% then unlike with apples the price will actual fall so the that yield can increase to compensate for the extra inflation that they expect.

          • Matt Tanous says:

            ” Inflation expectations would likely drive the price [...] of short-term treasuries down.”

            Why? I know that personally, if I expected inflation (and I do), that it would require more interest – in both short- and long-term assets – to induce me to buy. My demand curve would shift to the left, as it were.

            • Transformer says:

              For bonds with a nominal interest rate then the only way of getting more interest is to buy for a lower price.

              • Matt Tanous says:

                No, what you are buying then is a bond of a lower amount with a higher interest rate. The actual “price” of a bond is irrelevant in the first sale. What matters is the difference between the price you pay and what you get when it is repaid.

    • guest says:

      Something can earn “interest” in the form of purchasing power, rather than increases in the amount of that thing.

      Such is the case with gold coins:

      Interest Rates in a Gold Coin Standard
      http://lewrockwell.com/north/north1075.html

      On the other hand, some depositors may agree to be paid less interest. They may agree all the way to zero or very close to it.

      Why would they hand over their gold coins to the banks at zero percent? Because, in a free market economy, the production of goods and services constantly increases. This has been the normal situation ever since 1800. The greatest unanswered question of modern history is how this compound economic growth started when it did and where it did: Great Britain and the United States. But it did, and the world changed. Sellers’ competition drives down money prices. The real price of goods falls even when the money price of goods stays the same. People get richer even though the have no extra money.

      So, in a free market economy, the money (gold coins) paid by borrowers to lenders may not be more than the money borrowed – zero percent – but the real income of the lenders rises. Interest is still being paid to lenders, but it is concealed. The interest rate is the same as the decline in gold-denominated prices.

      Side benefit: no one pays income taxes on this increased wealth. Why not? Because the income in gold coins is the same as the outflow.

      Isn’t price deflation grand?

      • Matt Tanous says:

        I think North neglects the risk aspect of the loan. If I get the same benefit from merely holding the money as I do from loaning it out at zero, why bother with the loan, as there is a risk of default, however minor?

        • guest says:

          That’s a fair point. You would only loan at 0% if you thought that by doing so you would later have more money than if you had not loaned:

          Say that a gold coins owner goes to a banker. “I will pay you to store my coins.” The banker says, “Fine. That will cost you 2% a year.” The coin owner says: “That’s way too high.” The banker says: “I’ll tell you what. Let me lend out your coins, and I’ll put coins of the same weight and fineness back in the vault in a year. It will cost you nothing.” The coin man says: “But I won’t make any money.” The banker says: “True, but you also won’t pay any income tax. The gold in a year will probably be worth 3% more in purchasing power. And you will worry less about burglars.”

          • Matt Tanous says:

            Alright, I grant that one might take such a risk if they viewed the risk of theft as higher than the risk of the banker defaulting. I still don’t believe that anyone views the risk of theft as that high, without such a sum of money as to make the risk of at least partial default also increasingly high.

  3. Max says:

    If two bonds have the same cash flows, they should have the same price, yes? So what happens if one becomes scarce? Nothing. Bond buyers don’t fetishize scarcity.

  4. guest says:

    Since people trade their goods and labor to fulfill their own respective preferences, prices in a free market are going to reflect those preferences.

    But if a central planning agency co-opts the unit of account in such a way as to be able to inflate its supply, then when it spends newly created money it’s altering the measure by which people base their purchases and savings.

    People use money because it’s very difficult fo keep track of all the barter prices which would exist without it. So, inflating the supply of money causes people to misallocate resources away from the preferences they THINK are reflected in artificial purchasing power.

    Ultimately, the artificial purchasing power results in price inflation, which is the market saying “Those investments worked against your preferences”.

  5. JP Koning says:

    If the Fed is supporting asset prices above their fundamental value (whether these assets be apples or bonds) we should be seeing some sort of inflation (a falling purchasing power of the dollar). This inflation will be reflected differently in the price of apples and bonds. Bonds will fall in price with inflation, apples will rise. I think that’s why your David Beckworth sounds so funny when you switch bonds with apples.

    • Transformer says:

      That’s exactly the point that i was trying to make above.

      • Transformer says:

        From David Beckworth’s Market Monetarists viewpoint I think the idea would be to buy bonds and increase the money supply until NGDP is hitting the chosen target and then interest rates will be at the optimum/natural level.

    • Bob Murphy says:

      JP I think you just “proved” that the central bank can’t move real interest rates?

      • Transformer says:

        The CB can target inflation or it can target nominal interest rates. I don’t think ti could target both at the same time, which is what controlling real interest rates would mean.

      • JP Koning says:

        “I think you just “proved” that the central bank can’t move real interest rates?”

        I guess so. In the long term, at least.

      • Keshav Srinivasan says:

        Bob, are you claiming that real interest rate targeting is possible? How would you go about doing it?

      • Matt Tanous says:

        Bob, apparently, “move” means “control” now. I better go study from Transformer and Keshav, so I can learn this new English that is being used? I wonder if they still have “bad” or just replaced it with “ungood”.

        • Transformer says:

          Perhaps you are right and I mis-interpreted “move to mean “control”. (though one does need a certain degree of control in order to be able to move).

          But I agree with JPM that beyond the sort-run the CB probably can’t even “move” real interest rates.

    • Matt Tanous says:

      “Bonds will fall in price with inflation”

      Bonds rise in price with inflation – the interest rate (what you get for the price) falls. If the interest rate was cut in half, for instance, then this would be analogous to getting half as many apples for the price.

      Bond interest rates rise with EXPECTATIONS of inflation. Why? Because PEOPLE STOP BUYING THEM, trying to get more returns, even if they incur more risk doing so.

      • Jonathan M.F. Catalán says:

        Inflation will push down the real value of issued bonds.

        • Matt Tanous says:

          Yes, but I was referring to the purchase of new bonds. More money chasing those bonds will reduce the interest rates – this is how the Fed drives down all interest rates.

          Interest rates rise with expectations of price rises, however, as people seek “real values” away from cash and cash-denominated assets. These two tendencies counteract each other to different degrees.

          This is why Fed printing tends to lower interest rates for a time, before beginning to cause a rise in interest rates if they continue long enough. (And if they continued despite this, you get higher and higher rates of price rise.)

  6. Transformer says:

    Surely only that if the CB sponsors inflation then interest rates will rise as a result.

Leave a Reply