Status of Treasury securities

[John Hermann]

There has been much debate on this list about the extent to which MMT
happens to be a valid description of the operation of modern economies. 
It seems to me that at least part of the difference of opinion that has arisen
is associated with how one views the status of Treasuries.  One viewpoint
is that (a) they are a form of debt (and only a form of debt), while another
viewpoint is that (b) they are only debt in a superficial sense and should be
more properly regarded as a form of "broad" state fiat money.

An obvious analogy is term deposits made by the public in commercial
banks, which have some of the properties of borrowings and some of the
properties of money; whichever interpretation is chosen depends upon the
context and circumstances. 

The interpretation one chooses for the status of Treasury securities has
very important ramifications.  For example, one of the central assertions
of MMT is that deficit spending by a monetary sovereign creates and
injects net financial assets into the real economy (meaning into the hands
of the non-bank, non-government sector). The term "net financial assets"
simply refers to assets which are effectively unmatched by liabilities. The
question which then arises is what form those net financial assets take.  If
one subscribes to viewpoint (a) then the net financial assets are necessarily
identified with the Treasuries themselves.  However in regard to deficit
spending via the sale of newly created securities, if one one subscribes to
viewpoint (b), then the net financial assets may be identified with the
associated money spent into the real economy.

- John

[Joe Leote]

This 13 page pdf is a very good general discussion of classification of financial instruments:

https://www.cba.am/Storage/EN/publications/statistics/monetary_stat_manual/class.pdf

Securities other than shares are discussed on pdf page 4 (nominal page 27). These are described as negotiable instruments. Examples include Treasury securities and certificates of deposit issued by depository institutions (CDs). In the past I have said that in the United States a Treasury security is similar to an negotiable FDIC insured CD. In public discourse there is a tendency to think of CDs as insured savings (a good thing) and Treasuries as public debt (a bad thing). This is false reasoning when one recognizes that Treasuries and insured CDs are economic substitutes for each other held as financial savings by the non-government sectors of the economy.

Accounting customs list cash and cash equivalents. To the extent that T-bills or other highly liquid negotiable securities do not change value when interest rates change they are considered a cash equivalent. Typically the maturity is three months or less and markets must be highly liquid to qualify as a cash equivalent. Money market funds invest in highly liquid negotiable securities and thus their fund shares are listed as a cash equivalent (financial asset) on the books of the money market mutual fund investors.

Treasury securities that vary in value in response to changes in interest rates are not considered cash equivalents despite trading in liquid markets and having a risk-free default rating. When markets are putting "risk on" they want long term Treasury securities that pay a reasonable rate of interest. When markets are taking "risk off" they want Treasury securities more than other risky securities and the government can pay less interest. So the demand for T-bills versus T-notes & T-bonds varies based on risk expectations in financial markets. The way a central government prevents a deflation is to swap out some floating NAV assets for cash or cash equivalent assets in the aggregate asset portfolio of the non-government sectors. This helps stop a debt-deflation process that would occur when financial intermediaries are forced to sell assets to non-financial sectors under a paradoxical demand to hold more money at a time when aggregate credit is shrinking. Credit is the asset side of the FI balance sheet and must expand to generate stocks of money on the liability side.

Joe

 

[John Hermann]

Thanks Joe, that's an important distinction that you have made, between financial 
instruments whose value does not vary when interest rates change and others which
do.  I have sometimes seen highly liquid negotiable instruments (which do not change
value when interest rates change) described as "near money". 
           
- John

[Joe Leote]

John,

Also keep in mind that during the global financial crisis there were money market mutual funds and other money market positions that would have "broken the buck" (failed to hold par with currency) shortly after the Lehman bankruptcy except for the interventions of the Federal Reserve. This shows that "near money" or cash equivalents are not equivalent to cash during a money market crisis unless a Sovereign agent stabilizes the money markets by acting as the dealer of last resort as Perry Mehrling observes.

Joe

[John Hermann]

Interesting. So we have another important function of a Sovereign Central Bank,
which is often not mentioned, but is vital to maintaining the cash parity status of
near money, or cash equivalents.   - John

[Jean Erick]

    On the issue of what do you call it, I don't see the problem.

We have the history of the "money" of the rhealm being the King's debt, IOU (Britain).

    All one has to do is recognize what one is talking about and know the difference

between what some thing is, in Britains case debt, and how something is used, in that

case, as money.    In the US, money is created anew, via the process of using it to

pay a debt (Treasury usually.  Different with MBSs.)

   I mean, it's real simple.  You can use a shoe as a hammer all you want.  Just remember

that it's a shoe.

 

    We have to be clear about what we think money is supposed to be and what it is.

Money is supposed to be a ticket to ride.  A generic good that can be exchanged for any real good.

All the issue is that money is now a power.  It is not supposed to attain that status.

 

James

[helge nome]

I have a problem with the central bank being relied upon to bail out the system when it goes haywire, as in 2007/8.

The central bank should bail out the people (the victims) instead of the perpetrators whose habits created the problem.

Helge

---

From: understan...@googlegroups.com <understan...@googlegroups.com> on behalf of Jean Erick <jean...@sbcglobal.net>
Sent: June 15, 2017 11:25:33 AM
To: understan...@googlegroups.com
Subject: Re: Status of Treasury securities

 

[lante...@gmail.com]

Remember it is not just the Fed who bailed out the people but also the US Treasury. I think you'll find the Treasury did much more than the Fed ( Both in terms of amount of money as well as aggressive confrontation with Congress). 

Signature:    My compliments and best wishes.

[helge nome]

I believe the people controlling the Fed and Treasury are rather well connected; in some cases the same people wearing different hats at different times.

Helge

---

From: understan...@googlegroups.com <understan...@googlegroups.com> on behalf of lante...@gmail.com <lante...@gmail.com>
Sent: June 16, 2017 2:13:01 AM

[helge nome]

Joe stated:

"Also keep in mind that during the global financial crisis there were money market mutual funds and other money market positions that would have "broken the buck" (failed to hold par with currency) shortly after the Lehman bankruptcy except for the interventions of the Federal Reserve. This shows that "near money" or cash equivalents are not equivalent to cash during a money market crisis unless a Sovereign agent stabilizes the money markets by acting as the dealer of last resort as Perry Mehrling observes."

This is an interesting technical point but underscores the fact that the "Sovereign Agent" ( I. e: "We, the people") are used to bail out a fundamentally flawed system which continues on its merry way to the next crisis, where the players expect another bailout.

Helge

---

From: understan...@googlegroups.com <understan...@googlegroups.com> on behalf of helge nome <helg...@hotmail.com>
Sent: June 16, 2017 8:45:54 AM

[lante...@gmail.com]

Regarding: "A fundamentally flawed system......". I am afraid you are right.  😩

Signature:    My compliments and best wishes.

[Tom Paine II]

As usual, the nature of coins (at least as issued in the US) is misstated in the pdf. as follows:

 

“Currency - Currency represents notes and coins in circulation, which are of fixed nominal values and have no dates of repayment. Issued notes and coins are considered liabilities of the central bank.”

 

In the US, coins are assets of the central bank.  And they are not extrinsically deemed liabilities of the Treasury, which issues them.  When issued, US coins reduce the public debt, as that debt is officially defined.

 

From: Joe Leote

Sent: Wednesday, June 14, 2017 12:28 PM

To: Money Group

Subject: Re: Status of Treasury securities

 

[John Hermann]

I would make the additional point that Treasury securities as
a whole are overwhelmingly on par with the currency.  Even if
one takes cash flows into account, I think it correct to say that
only a small proportion of Treasury securities overall are
linked to inflation.   - John

Interesting. So we have another important function of a Sovereign Central Bank,
which is often not mentioned, but is vital to maintaining the cash parity status of
near money, or cash equivalents.   - John


On 15/06/2017 11:14 AM, Joe Leote wrote:

[Joe Leote]

When Interest Rates Go Up Prices of Fixed-Rate Bonds Fall:

https://www.sec.gov/investor/alerts/ib_interestraterisk.pdf

A rule of thumb for money market instruments is that securities maturing in less than three months are usually expected to remain at par with currency. This should be true for Treasury bills which have political risk of default but otherwise may be considered default free securities. Corporate securities may have counter-party default risk and such investments will break par in the event of default.

Treasury securities (and all corporate notes or bonds) paying a fixed interest rate with longer maturities will always fluctuate in price whenever interest rates rise or fall.

Joe

[lante...@gmail.com]

Re: If interest rates go up, fixed-rate bonds fall....is this how the 'Risk Level Tiers" are determined in Stress Testing?

Signature:    Salute and greetings.

[Joe Leote]

I am not familiar with Risk Tier Levels or the details of complicated computerized stress test simulations. I understand some basic principles.

Interest Rate Risk is just one of many factors that must be simulated in stress test models. It applies for many financial instruments that fluctuate in net asset value when interest rates change. Notes and bonds are just two types of financial instruments that are relevant to such analysis.

Joe

[Jean Erick]

     Again, I see the absence of certan realities.

 

    Parity with currency seems to be a slight move away from simply the "inflation" word.

Before the Reagan era, the Galbraithian wonderland of inflation decreasing the purchasing

power of Treasuries resulted in the "something for nothing" era, where one borrows then

pays back in dollars of less purchasing value.

   Then the Fed started stressing low inflation which changes the basic paradigm.

All this overshadowed by the oligarch doing their 80-100 year Kondratief Wave called

"profit taking" via the real estate bubble and burst.

 

    I'm just sugggesting that my view provides a more basic floor to the activities

you are talking about.

 

   And, noting the fact that "Sovereign" is used to describe the Central Bank.

Who is the "sovereign"?  The US?  The Central Bank?  Me?  The "commies".

 

James

 

----- Original Message -----

From: Joe Leote

To: Money Group

Sent: Monday, June 26, 2017 8:44 AM

Subject: Re: Status of Treasury securities

When Interest Rates Go Up Prices of Fixed-Rate Bonds Fall:

https://www.sec.gov/investor/alerts/ib_interestraterisk.pdf

A rule of thumb for money market instruments is that securities maturing in less than three months are usually expected to remain at par with currency. This should be true for Treasury bills which have political risk of default but otherwise may be considered default free securities Corporate securities may have counter-party default risk and such investments will break par in the event of default.

[Joe Leote]

Again ... with the King James Version of reality.

Joe

[helge nome]

"THOU SHALT BE FORGIVEN FOR ALL THY TRESPASSES!"

---

From: understan...@googlegroups.com <understan...@googlegroups.com> on behalf of Joe Leote <joel...@gmail.com>
Sent: June 30, 2017 2:40:48 PM
To: Money Group

[John Hermann]

Joe said:  " Treasury securities (and all corporate notes or bonds) paying a fixed interest rate with longer maturities will always fluctuate in price whenever interest rates rise or fall. "

The meaning of this statement is unclear to me.  Consider the following statistics from the Reserve Bank of Australia:

http://aofm.gov.au/ags/treasury-indexed-bonds/
http://aofm.gov.au/ags/treasury-bonds/

We see that Australian Treasury indexed bonds (those whose interest rates vary, according to the whims of the money markets) amount to little more than $30 billion, whereas Treasury bonds (whose interest is fixed) amount to something in the range $400 billion - $500 billion.

If the latter bonds pay a fixed interest rate, why would their price vary?  I would have thought that a stable interest rate implies a stable price.

- John

[Joe Leote]

John,

I put up a link to a five page paper describing the basic answer to your question. As I understand the terms an indexed bond is indexed to inflation. This is different from fixed rate bonds.

The market value of a fixed rate bond goes down when interest rates go up because investors have the option of buying an older bond with lower interest rates or a newer bond with higher interest rates. If the prices of old bonds did not adjust downward they could not sell on the market against comparable bonds with higher interest rates. If an investor holds to maturity and there is no default the investor collects the face value and promised interest payments so the change in market value is not relevant except for firms that must mark their investments to the market price periodically under accounting standards.

Joe

[Jean Erick]

     Well, your're close Joe.  But the full appelation is "King mouse".

The King James (version) is the most known version of the Holy Bible.

As in "Give me the child until 7 years and we will have the adult for life."

- Catholic church.

 

    Which brings us to the question from what some consider as the primary source. 

Jesus Christ.  What did he say on the cross?  "Forgive them Father, for they know

not what they do".  NOT is the essence.  Referring to the fact of the immediate crucification

but more broadly to the reasoning behind the killing.  Forgive us our sins.  The words for sin

and debt were synonymous.  "Foregive us our debts."  Christ, as many philosophers throughout

time were not about abstract concepts.  They were all about economics.

     He was about bringing back the Jubilee forgiveness of sins/debts.

 

     He was one of many prophets stemming out of the many new religions starting

about 600 BC.  A reaction to the brutality used to intstall the creditor rule.  Apologists

for the violence.

 

     What is hard for me to accept is how successful this violence has been down through the ages.

How can it be this way?  But it seems to be that way.

 

    Right down to todays mythology which eradicates critical thinking.  As possibly suggested

via the Bill Moyers-Joseph Campbell series on "The Power of Mythology."

 

BTW, the Galbraithian miracle, Kondratief Wave, and Greenspans statement about

inflation being low due to the fear of workers are not creative manifestations of my mind.

The are "exogenous" to my creations.  They are facts that anyone who considers themselves

educated in this area should know.

 

    And, it's not good policy for a forum head to engage in smart mouth putdowns.

[Joe Leote]

I regard many of your comments directed toward me as a form of "smart-mouth put down." If it is not good policy to engage in such tactics then I suggest you stop directing comments toward me in the future.

Joe

[lante...@gmail.com]

Don't be too Thinned-Skinned, Joe. Your items are good, have lots of confidence.  Be patient, tolerant. Keep sight of the main objective - To help people understand money.

Signature:    Salute and greetings.

[John Hermann]

OK Joe, what you seem to be saying is that there is a trade-off between
the tradeable price of a fixed rate bond and the total interest return that
would be expected to be received over the life of that bond up to maturity. 
The nature of that trade-off is unclear to me.  For example, would it be
correct to say that the sum of the tradeable price and the expected interest
to maturity is a constant (i.e. that the sum is conserved) or approximately
constant?  Clearly, in that case it would be correct say that the "value" of
the bond is on a par with the currency.  If that simple prescription is incorrect,
do you have insight into the mathematical relationship between the two
components making up the bond's value?   I am breaking the total value
down into short term value (the tradeable price) and long term value
(expected interest return to maturity)   -  John

[Joe Leote]

John,

This article describes the basic principles of bond valuation which is to apply the net present value formula to each expected future cash flow:

http://www.investopedia.com/walkthrough/corporate-finance/3/bonds/valuation.aspx

This paper is 52 pages showing the present value formula for a "straight bond" on page 2:

http://people.stern.nyu.edu/adamodar/pdfiles/valn2ed/ch33.pdf

When interest rates rise the discount factor on outstanding bonds increases so their present value decreases.

In general the discounted cash flow models are used to compare financial instruments that have different cash flows and expected risk profiles, or to compare investments in plant, property, and equipment with different life cycle costs and expected revenue streams.

Joe

[John Hermann]

Thank you Joe.  It would be very helpful to our understanding to have
these relationships (tradeable price value, and expected total interest
return to maturity) plotted graphically as a function of (variable) interest
rate  - John

[Joe Leote]

This article shows a graph of bond price vs bond yield illustrating the property called "convexity":

http://thismatter.com/money/bonds/interest-rate-risk.htm

I am searching for a good reference of software package that demonstrates the basic principles of bond portfolio management.

Joe