‘The money story’ told by a father of MMT


Alan Kohler speaks with one of the founders of modern monetary theory, Warren Mosler, to take us through 'the money story' and the origins of modern monetary theory, how it applies to the COVID-19 pandemic, and his own journey as a successful bond trader and fund manager, where he put into practise his ideas of modern monetary theory.


By Alan Kohler, 4 Aug 2020


Warren Mosler is one of but possibly the originator of modern monetary theory, but he did collaborate with Bill Mitchell of The University of Newcastle, who I interviewed in March, among other people. Warren is talking to us from The Virgin Islands where he lives on the Island of Saint Croix. But the difference with Warren Mosler is he’s not an academic, he is a fund manager, started off with a big bankers trust or a group of other banks, eventually had his own hedge fund trading bonds and essentially, put into practice his ideas that became known as modern monetary theory.

I suppose the key insight is here, that what he’s talking about is actual operations of money, not theory. He’s an operational guy and the way he approaches it is in the way the monetary system actually works. He’s really clear, really worth listening to and it’s long but really worthwhile.

Here’s Warren Mosler, one of the founders of modern monetary theory.


Alan Kohler:

Warren, it occurred to me that maybe a good place to start would be the insights you started to have in the 70s, when you were a fairly young bond trader – I can’t remember who with but at some stage, BT, and I think you moved around a bit…

Mosler:

Yeah.


Alan Kohler:

I mean, those were the peak times of what we call monetarism and Friedmanism and so on, and I think you started then saying that the Emperor had no clothes. What exactly did you identify as the problem?

Mosler:

I can only remember bits and pieces from back then. I remember being at bankers trust and the Fed had raised reserve requirements and the trading managers, Allan Rogers – and he talked without moving his mouth like this, and he said, “Why I hope the Fed doesn’t just give them the money. The money supply is too high, they need to take the $10 billion or whatever it is out of the economy.”

And I remember saying – I was a fairly new trader there, I was 27 years’ old – I go, “Allan, you can’t do that, you can’t just – you know, it’s just a spreadsheet, you can’t take the money out, they have to add the money. They always add the money because otherwise it’s, in the first instance, the reserve requirements are debit and so then they either have an overdraft which is a reserve-add or you have to buy securities as a reserve-add. Since the overdraft would cause the Fed funds rate to go up 100 basis points, they don’t want that to happen, they have to just do repos or add to reserves.”

He goes, “Well, they could bring back those Euro dollars, there’s 300 billion Euro dollars sloshing around.” I go, “No there aren’t. There’s a spreadsheet over there with assets and liabilities, there’s nothing sloshing around, you can’t bring those back, that’s just empty rhetoric…” He didn’t really want to hear that. One of my clients was Cliff Viner at Phoenix Mutual, who later became my partner, and he directed my attention to an article in the Wall Street Journal by Eric Heineman, “The money supply is too high, I hope the Fed doesn’t just give them the money but takes it out.” I explain it to him and he was a client of Morgan Stanley so he called them with my answer and he calls me back with their double-talk answer and I straightened that up. He calls them back and then he calls me back and he says, “They’ve retracted their statement. They agree that you have to add the reserves.” So, I don’t know, maybe that was part of the pieces of the puzzle.


Alan Kohler:

Well, the point of this part of the story is that what you were doing then was about operations, not theory. I mean, you’re an actual trader and what you’re talking about was the way that the system works, not some kind of economic theory.

Mosler:

That’s right, exactly. The debits and credits that happen whenever there’s a transaction.


Alan Kohler:

The other phrase that I love that you’ve come out with – and I’ll need you to explain – is that tax liability creates unemployment. Explain that.

Mosler:

Right, by design.


Alan Kohler:

By design – so explain that and tell us about Pompei.

Mosler:

Yeah, so you have to start the money story somewhere and if you go to a textbook usually they don’t know what money is or anything like that but what it does and it’s a medium of exchange and it’s kind of mysterious. But for me, the story begins with a state that wants to provision itself. You’ve got a government, in this case, it was Pompei and I’ll tell that story in a minute, but the government wants to provision itself, it wants people in the military, it wants a public health department, it wants public education and it wants all kinds of things, a legal system… There’s been some determination that that somehow serves public purpose. You’ve got a government that needs to provision itself with people and food for the cafeteria and weapons and whatever it needs – so how do you do that?

That’s how the money story starts for me. What happened was, as a point of logic, that’s where the money story starts. What they do is, sure, they can come up with a currency but how do you get anybody to accept it, as Minsky had said, “Anybody can come up with money, it’s how do you get anybody to accept it.” The United States can come up with this new thing called the dollar, but there’s nothing for sale with a dollar price tag on it when you first come up with your new currency…


Alan Kohler:

And the thing you kind of said was, the government can say, “We’re going to tax people.” The trouble is, the people have got no money at that point.

Mosler:

Right, so what you do is you establish a tax liability. That’s what comes first. First is a desire to provision yourself, to be able to have soldiers and judges and lawyers, so the next step to do that is to put a tax liability on and something that nobody has. You put a tax liability, let’s say, on everybody’s house to keep it simple, in US Dollars. Nobody has any, so now they’re all out looking for work so they can earn US Dollars so they don’t have to lose their house. Now the government can hire those people with its, what I call, otherwise worthless dollars. When you see that term, otherwise worthless, you know that came from me because that’s how I started talking about it at the beginning.

So the tax liability creates people looking for paid work in that currency. That is the definition of unemployment. It’s not people looking to volunteer at the Cancer Society who can’t find work, it’s people working for paid work because they need the money. That’s the definition of how we define unemployment. Unemployment as we define it is a monetary phenomena, it’s people looking for paid work. When the government does that it deliberately puts tax liabilities in place to cause people to need paid work so it can hire them to be soldiers and judges and school teachers or whatever it wants, and so it’s all by design.


Alan Kohler:

But it’s not so only the government can hire it, I presume. I mean, those people can get other work that will provide them with dollars, right? But their employers have to have dollars, right?

Mosler:

Well, the dollars to pay taxes can only come from government agents, period. Otherwise, it’s what’s called counterfeit and you go to jail for that. It’s always the case the government or its agents are the only source of the dollars to pay taxes. In the United States, its main agent is the central bank, the Fed. Then the Fed has all the member banks which it’s empowered to be able to accept liabilities or their dollar deposits as payment of taxes that clear through the Fed. But if you’re not a member bank, then you cannot create dollar liabilities that can directly be used to pay taxes, you have to go through a correspondent bank.

That’s true of every central banking system in the world right now, that the funds to pay taxes come all the way from the government or its agents – it’s always government agents of course. The Treasury Secretary doesn’t go around and do anything, he has agents.


Alan Kohler:

It’s very interesting, Warren, Margaret Thatcher said in a speech to the Conservative Party Conference in 1983, she said, “Let us never forget this fundamental truth, the state has no source of money other than money which people earn themselves. If the state wishes to spend more, it can only do so by borrowing your savings or by taxing you more. So, she made a mistake, right, you’re saying?

Mosler:

Yeah, the same thing happened with President Obama. He said, “Well, you know, the money comes from the government.” And they all shouted him down and said, “No, government can’t create wealth, the private sector creates the wealth, the government then has to transfer the wealth from the private sector.” Well, they confused wealth and money in that statement. But Obama backed down and he said, “Okay, you’re right.” [Laughs] That wasn’t that long ago. Thatcher was a while ago, but yeah, it was completely wrong.

Now, let’s look at Pompei, because this is all illustrated very neatly. My wife and I were on a tour in Pompei, one of those little public tours, about 20 or 30 people, and the guide showed us the coins that they – they were just simple metal coins, but he said, “Pompei was a very nice place to live because they would collect these coins as taxes and then they would pay people to have sanitation and public safety and whatnot. And I said, “Actually, the way it worked was, first they would pay the people and then they would collect the coin.” So he said, “No, you collect taxes and then you pay the people.”

I said, “Well, where do coins come from?” He goes, “Well, the government made them.” [Laughs] And so I said, “How did anybody get a coin to pay the tax? They paid the people first and then they collect the taxes. How else can it work?” And he goes, “No, no, no, no, no…” and he grabs his head, walked away and he wouldn’t talk to me for the rest of the tour. I guarantee you, everybody in Pompei new how it worked. They put a tax on your house, now you needed the government’s coin to not lose your house. People would go to work, earn coins, get paid, do the public service that they all liked.

Most of the people didn’t do that though, maybe 25 per cent of the people would build the aqueducts and clean the streets and be police officers. But there were other people who were farmers and bakers selling pizzas, and they would get the money from the people who were working who didn’t want to be a farmer and didn’t want to make pizzas and didn’t want to do those things and raise chickens, and the place was monetised and so those people would sell things to the people who work for the government to get their coins to pay the tax, right? And it was pretty obvious how the system worked because it was simple and there was no dispute over the fact that that’s how it worked.

Here you have a state that wants to provision itself with people to keep it clean and people to keep it safe and so they put a tax on everybody’s house. That caused unemployment, that’s what they were trying to do, people looking for paid work in the currency of Pompei. They then paid those people, then the tax was paid, and that was the flaw.

Arthur the Great in England – I was in Cambridge in a library and somebody was showing me his work about coins and I started explaining it, he goes, “Yeah, yeah, yeah, that’s how it worked.” [Laughs] I don’t think there’s any dispute. I give another anecdote about the British and Africa trying to grow coffee, it’s the same thing, they put a tax on everybody’s hut, people show up at the plantation to earn the funds to pay the tax so they don’t get their house burned down.


Alan Kohler:

In that history of money and taxes and employment, where does slavery fit?

Mosler:

Well, that’s another way to provision the state, you just send the army in and take slaves and force them to do things. The British would go to bars and pick up drunks off the floor and put them in the navy. I mean, there’s different ways to provision government. We pretend to be more civilised for this course of taxation. Anyway, I just came up with a concept and then all these MMT proponents who have been serious students for a long time like Randy Wray, Stephanie Kelton, Bill Mitchell… They went out and dug through the history books and found examples to show that, yeah, this was how it actually worked. I had no idea when I just came up with a logic.


Alan Kohler:

What do you say a government deficit is?

Mosler:

All right, so let’s look at Pompei. They found like 20,000 coins in what would have been somebody’s pocket, what was a street, or what would have been a shop, when they dug through all the lava or ashes. But how’d they get there? Well, obviously they came from the government, so they must have spent more than they collected in tax. They had a tax liability on everybody’s house, it might have been 10,000 coins a year. People showed up for work and wanted to earn 15,000 or whatever – what did they care? It’s just cheap metal coming out of the coin box.

And they hired the people they needed to do all the work and paid them and some of those coins were used to pay taxes and others were saved to function as the money supply in Pompei. They had cash in cash registers, savings in their pockets, parents took them home to Rome as souvenirs or whatever people do with money, right? They don’t use it to pay taxes…


Alan Kohler:

But that’s a surplus, what you’re describing is a surplus…

Mosler:

No, no, that was the state’s deficit. They spent 15,000 and would get 10,000, the other 5,000 were in the street. They spent 100,000 and only collected 80,000.


Alan Kohler:

This is what Stephanie Kelton says, which is that a deficit is a transfer of money from the government to the private sector.

Mosler:

Yeah, what I say is it’s the money spent by the government that hasn’t yet been used to pay taxes. In Pompei, they spent 100,000 – 80,000 was used to pay taxes, the other 20,000 was still in the street 2,000 years later, hadn’t yet been used to pay taxes. It’s the money supply.


Alan Kohler:

How did we get to this point where the state requires a buffer of unemployment in order to control inflation?

Mosler:

Good question. So, let’s just first talk about where that comes from. The United States has a tax structure that creates 10 million unemployment – more now, but this was before this last crisis – and then the government only hires 3 or 4 million of them and the others just stay in the street. They created more unemployment with the tax than they wanted to hire, so they either needed to hire 7 million – the only reason they’re there is because of the tax – or lower the tax so that they don’t create so many unemployed, right? And what I’m talking about is a fiscal adjustment, you either increase spending or cut taxing.

Same thing in Pompei, if they had too many people show up, they might put a tax on 10,000 coins a year and they have people showing up to earn a lot that they don’t want, they don’t want that many people, why are these people showing up? Because the tax of 10,000 caused that many to show up. Nobody showed up before the tax. With no tax, nobody shows up. If twice as many people showed up, they made a mistake, the tax should have been 5,000 instead of 10,000. Or they can hire more people for public services, right? It’s not complicated.


Alan Kohler:

But the conventional wisdom is that the only productive jobs are in the private sector.

Mosler:

Well, somebody has decided that there’s a place for collective action. The military is best done by the government and the legal system is best done by the government and certain things everybody agrees on, other things the right might think is extraneous and the left thinks it’s critical, then you settle on it but you come up with what you might call the right-sized government producing public infrastructure for public purpose as determined by the electorate or the king, whatever. It’s determined that collective action is to the benefit of society and that’s why you have people in government and that’s why you have people in the private sector. You put everybody in government, there’s nobody left to grow the food, you’re all going to die, right? If you put nobody in government, you can’t defend yourself and you lose the war. The answer is somewhere in between. It’s not an easy question, it changes.


Alan Kohler:

He calls it an inflation tax, that is also a conventional wisdom.

Mosler:

Yeah, but it’s clearly not legally a tax. It’s a way to think about it. And so what point is he trying to make? That the private sector is giving up real resources when the government deficit expands? Yes it is, because the government’s buying something that moves from the private sector to the public sector and the private sector is giving that up, that’s a tax. Whether it’s done through purchasing power or done through this other method, the direct tax when it’s actually paid is when the government purchases it and takes it away from you. It buys a can of beans and takes it off the shelf, it’s gone – the private sector just paid a tax of one can of beans to the government.

Whether they paid $10 dollars for it or $20 dollars is a different matter, I’m not saying it doesn’t have consequences, but if you want to call inflation a tax as kind of an analogy, that’s fine, but it’s certainly not legally a tax. And the semantics are important because they create all this imagery of things that causes people to be for or against policies for the wrong reasons.


Alan Kohler:

One of the points you often make is that the spending by the government takes place before the taxation or debt issuance, that is to say, the money is created to undertake the spending before the government actually raises the money. I don’t know what it’s like in the US, but in the case of Australia, the government actually maintains a credit balance in its bank account with the Reserve Bank, so the money is actually there, sitting there. When it instructs the Reserve Bank to credit someone else’s bank account, the money actually comes out of a credit balance, not a debit balance, it’s not in overdraft. Does that change your point?


Mosler:

No, because what I’m saying is from inception, so at any point in time, apart from inception the Treasury can have a positive balance, but how did it get a positive balance on day one? There were no Australian Dollars. We start a new country, the British would go and declare independence as the new Australian Dollar, you set up a spreadsheet called the Reserve Bank, nobody has any of these things yet and you start taxing – well nobody can pay the tax until after you spend the money. It’s like Pompei, nobody could pay the coins until after they were spent. Everybody in the Reserve Bank knows that. They way they say it is, you can’t do a reserve drain without doing a prior reserve add.

In other words, on settlement day when all the treasury securities need to be paid for, the private sector of the banking system can’t do it, it would cause all their accounts to go into overdraft, which is okay but an overdraft is a loan from the Reserve Bank. And so the Reserve Bank has to add those funds either proactively through a loan or reactively through an overdraft which it allows banks to have, which is also a loan. The money comes from the Reserve Bank to send to the Reserve Bank, it can’t come from anywhere else. It’s just a spreadsheet, it’s what you call ‘inside money’. It’s a very simple setup.


Alan Kohler:

One of the things that Stephanie Kelton says, which I really like, is that government bonds are simply money that pay interest.

Mosler:

Right, they’re bank accounts at the reserve bank that pay interest. The Reserve Bank has two kinds of accounts, I think they’re called reserves and securities – at least, that’s what they’re called over here. They might call it a cash account and a securities account, I’m not sure what they call it over there. But they’re what’s called a cash account and then a securities account which will have all your bonds. When the government spends, the Treasury spends, they debit the treasury’s account, then they credit the cash accounts of the appropriate banks, whoever they’re paying – if they’re paying somebody, that person has a bank and they credit that bank’s account at the Reserve Bank. They credit cash accounts at the Reserve Bank, then they offer securities and when those are purchased, they shift those dollars from the cash accounts to the securities accounts.

Then when the securities come due, they shift those dollars from the securities accounts back to the cash accounts. There’s no taxpayers or grandchildren anywhere in the room, it’s just a shift between two different accounts that bank accounts with dollars in them at the Reserve Bank. They could have just as easily called them a chequing account and a savings account so that people will understand that they’re the same as any other commercial bank with a chequing account and a savings account. Is money in a savings account not money? Is money in a chequing account more money than money in a savings account? No.


Alan Kohler:

That’s great. Tell us how a job guarantee fits in with these ideas?

Mosler:

Let’s go back to our money story. There’s a tax structure in the economy, it creates in the US 10 million unemployed, the Federal Government hires 3 million of them, 7 million remain unemployed because the tax created more unemployed. Now the government recognises it’s made a mistake, doesn’t want to hire 7 million more people, it’s already got the size government it wants, let’s say – or maybe it wants to hire a couple million more, so it hires 2 million more, but it doesn’t want all 7 million. The other 5 million are unemployment because this tax caused them to be unemployed.

It means that the fiscal policy was too tight, the tax was too high for the amount of spending and how do you get them back into the private sector? Well, you can lower taxes and now there’s enough money in the private sector, enough demand, so they could hire them but they don’t. Because the private sector doesn’t like to hire people who have become unemployed, particularly for a longer period of time. They don’t know if they get in fights or they take a bath every day, are reliable, come in on time…

The private sector will train people if they’re decent people and have a good recommendation, they’ll give them a shot and train them in a good economy. But they don’t like unemployed, they’d rather just take somebody who’s already working and give them a little extra money and hire them. There’s lots of studies that have shown this for the last 30 and 40 years, it’s not some new thing we made up. The best way to transition them from unemployment back to private sector employment is by putting them in this job guarantee. Offer a job to anybody willing and able to work, they show up to work, that automatically increases their eligibility for private sector employment and they will get hired by the private sector. There’s lots of evidence that this works beautifully.

Argentina’s the big one where one of our associates, Daniel Kotze was with the Labour Ministry in Argentina and in 2001 after Argentina blew up with 32 dead in the street, fixed exchange rate blew up, they floated the peso – he implemented this program called the Jefas de Hogar where they offered a job to any head of household who wanted to work. It was more limited than I would have done, but it was any head of household. They got something like, over a couple of years, 2 million people enter that job guarantee. They were people who had never worked in the private sector and nobody ever thought they would. They were considered disadvantaged, they were Indian ancestry and things like that where it was not even thinkable that they were part of the normal economy.

Within a couple of years, over a million of them had transitioned into the private sector and Argentina had the best economy in the world, the best growth rate, with no labour pressures in the labour market. They have a stable thriving labour market and economy because of this thing. So we know that works. What we’re saying is – you know the story about, you don’t have to out-run the bear, I only have to outrun you? Have you every heard that?


Alan Kohler:

What do you mean?

Mosler:

Well, we’re both walking in the woods and there’s a bear, and you say to me, “What are you going to do?” And I say, “I’m going to run.” And you say, “Well, you can’t outrun the bear.” And I say, “I don’t have to outrun the bear, I just have to outrun you.” [Laughs]


Alan Kohler:

Yes.

Mosler:

So the job guarantee, as far as I’m concerned, only has to be better than unemployment to be put into place immediately, because unemployment’s horrible, right? So if you could just show that in every possible way, it’s even equal to unemployment but it’s better in every way. And so, what it does is it provides – we have unemployment to fight inflation. The job guarantee does a better job of fighting inflation, because the people in the job guarantee are more employable by the private sector, so they prevent bottlenecks and shortages in the labour markets where people who are unemployed don’t because the private sector doesn’t want to hire them.

It improves the liquidity of the labour market in that sense and provides for that transition and so it’s a superior price anchor. If the point of unemployment is price stability, well now we’ve got a better way for price stability called the job guarantee…


Alan Kohler:

We’re all brought up to believe, to know that employment and unemployment is a function of aggregate demand.

Mosler:

Right, right, it’s also aggregate demand, but when aggregated demand picks up, we get inflation long before we get low unemployment, many times. Europe had the NAIRU figured at like, 10 per cent. Why aren’t those other 10 per cent being hired by the private sector? Why are wages going up and having inflation when they’ve got 10 per cent unemployment? Why was it happening in the US…?


Alan Kohler:

I find it hard to believe that kind of a broad theoretical sense, that private sector won’t hire unemployed people if they could make money out of hiring them, you know what I mean?

Mosler:

It’s too risky. They will, but they’d rather hire somebody who’s already employed and you get wages going up in the private sector even as unemployment lingers at high levels, particularly with long-term unemployed, six months, a year, two years – the longer they’re unemployed, the less the private sector wants to take a chance. It’s high-risk to hire somebody, it’s expensive and then if you have to fire them that’s expensive and creates problems and it’s unpleasant. Nobody wants to do that. You’re going to run a business, you want people who were working somewhere else, they come in, you know they’re going to step up, do their work and it’s going to run smoothly, your business is going to run smoothly.

You don’t want to suddenly find you’ve got a drug addict there or somebody who doesn’t show up every day. They have no way of know that with unemployed, so it’s a risk. But you can look up the studies, there’s lots of them. This is not a theory of my part, this is pretty well established that that’s the case. In fact, there was anecdotes in 2009, it’s like, ‘Help wanted – unemployed don’t show up, if you’re unemployed don’t look here, if you’re employed somewhere else, we’re looking for people.’ Anecdotally, there were businesses advertising that way, that they wanted people who were already working with a history of a work ethic and employment ethic.


Alan Kohler:

I think one of the more interesting and important parts of this story, Warren, is your own success, firstly, as a bond trader and a bond money manager, and the transition you undertook from BT to William Blair and then setting up your own fund. Can you take us through how that happened and why you were successful?

Mosler:

A lot of it is, I walked into what’s called an institutional structure that happened to fit my aptitudes. For some reason, I’ve always had a knack of seeing financial transactions, financial statements and being able to kind of look through them and see what’s going on underneath. I don’t know why, it’s just something that came naturally. I struggled with languages. I’d go to Spanish class in high school and people were learning much faster than I was, but when it came to finance, somehow I just had an aptitude for it.


Alan Kohler:

It’s possibly because you’re an engineer – which we’ll get to later.

Mosler:

Yeah, a struggling engineer, I had a one-eight average, almost flunked out, I had to switch to economics to graduate, [Laughs] because it was easy.


Alan Kohler:

Anyway, carry on.

Mosler:

Yeah, so I couldn’t get a job for a couple of years. I got out of school in 1971, we were in the middle of a recession and a bad recession. I go into an interview and they’d say, “I don’t know why we’re here, we’re letting people off.” But I did get a job in a bank in 1973 after I got a haircut, that was a lot more important than I realised. I got a very short haircut and got a job within a month. [Laughs] so it was a different time back then. My first job was collecting – it was a very small bank, a savings bank and I was there to collect delinquent wallets and that type of thing. But again, I had an aptitude for it and the Vice President got moved to President and he had been doing investments, so they had me look at investments. I started there in 1973 and in 1975 I was the Investment Officer, had all of $5 million dollars in CDs and $5 million dollars in stocks, but I met with the brokers and I met with the people doing that type of thing.

I remember I had to do a short-term investment and I was looking at markets – I don’t know why, and Ginnie Mae’s was just trading in government national mortgage backed securities. I started trading month to month, you could buy them from March, delivery in April, May, June, July. And some were different prices for different months and I just calculated, just arithmetic, that if I bought for March and sold for September, that was six months, I would make 5 per cent on my money. They had 8 per cent coupons, so I’d make 8, but take a loss on the price, so I’d give back 3 and I’d wind up netting 5 per cent. I did a million dollars’ worth of that for the bank of their money instead of 4 per cent which was what all the other short-term investments were, so it was only an extra 1 per cent, there was no huge windfall. When you’re in fixed income, that’s a lot. Most people can’t add that kind of value.

I remember it was Friday night, eight o’clock at night, I get a call from Jim Saxton who was my coverage at Solomon Brothers, who was the largest fixed income firm in the world at the time, he says, “Warren, look, we’re in a sales meeting here and we’re talking about your trade. Can you go over it one more time and tell us how it works?” [Laughs] That’s enough to swell your head up, you’ve got to run out and get a larger hat size, right? [Laughs]

That was when I was still at the bank in 1975. My contact at Bankers Trust, Jay Palmer – I went from there to Baeshan Company which is one of my other contacts, he hired me and then six months later, Bankers Trust, who had known me working at the Savings Bank, hired me to come out there and do sales and trading of Ginnie Mae securities – all I had done was that one trade and I was at Bankers Trust as Vice President of Sales and Trading of Mortgage-backed Securities. I had more experience than anybody else, it was a brand new market, right? And stepped in there and we were the first ones to make calendar spreads in futures and options and all kinds of things. The Board of trade had contracts for Ginnie Mae securities and bonds, and started dreaming up all kinds of trades and arbitrages for those and we did extremely well.

One of my clients was with William Blair & Company, I showed them all these positions they could put on, trades to make money and they couldn’t do any of them but he finally said to me – Buzz Newton – he said, “Look, would you like to come out here and do it for us?” And I said I was already making a pretty good salary here at Bankers Trust. He said, “Well, we don’t have a salary, we just get paid a regular retail payout, we’ll give you 30 per cent of whatever you can make.” So the way I tell it, that was a Wednesday and I started Monday – I think there might have been an extra week in there but…[Laughs]

That was December of 1978, I went off the Bankers Trust and started doing these things for William Blair & Company and at that point, we just started making serious amounts of money doing this type of thing that I’d been doing. From there, in 1982, that’s about three or four years later, the markets were much larger than William Blair, they only had about $10 million dollars of capital back then and so the idea was to raise more capital to be able to do these trades in more size and so we started this fund called Illinois Income Investors with William Blair who had an interest in it and then set up another firm, ABM, for broker-dealer operations so we could do that and eventually move that onto Florida in I think 1984 and William Blair remained a partner for a while.

At some point in time, they just cashed out. That firm still exists – I run it for 15 years, at the end of 1997 I turned control over to my partners and got blamed by the New York Times who said, “Mosler’s not as good as he thinks…” or something, “In 1998, his Russia fund lost all its money. I’d left the firm at the end of ’97 and they knew that, I told them that. It was just a hit job that this New York Times did. When I hear of things like fake news, I have a particular sensitivity and personal experience on things like that.


Alan Kohler:

But those trades you were doing for those firms and your own fund, to what extent were they informed by your ideas that we now call modern monetary theory?

Mosler:

The largest one was in the early 90s where Italian bonds were paying 12 per cent and you could borrow the Lira to pay for them at 10 per cent. So you just buy the 12 per cent bonds, you borrow the money at 10 and you make 2 per cent for doing nothing, it’s just pretty easy money, right? Except, if the bonds defaulted you’re going to lose everything and if the currency went down it didn’t matter, you still made 2 per cent in Lira, you’d just have a little bit less profit than you thought. So it wasn’t a currency risk but it was just the idea that it might default. The question became, if you can come up with reason why they won’t default, this is a good trade, this is maybe the best thing we’ve ever seen.

And so, the first thing I realised was that governments with their own currency, historically I didn’t know of any of them that ever defaulted, I didn’t think there ever was such a thing…


Alan Kohler:

Well, a default is said to be when bond investors take a haircut.

Mosler:

Yeah, so that never happened with US bonds in Dollars or Spanish bonds Pesetas or Greek bonds in Drachma, it never happened, nobody ever took a haircut on bonds, there was all values been shorted par. The reason given was, was because they could always print the money. When you looked at it, nobody ever printed the money and they still never defaulted, so I said, all right, it’s got to be more of a reason than that, otherwise, it would’ve happened at least once in the history of the world. When I talked to S&P about it, they didn’t have anything except there were some defaults in Brazil when the inflation was so intense that the value of the bonds was a quarter of a penny and the bondholders didn’t bother to cash them in so they considered it a default.

They had 1943 Japanese bonds in Yen, held by the US Government that Japan didn’t pay, didn’t credit the account. The Bank of Japan, they defaulted, so it’s like, okay, that’s kind of understandable. So there’d never been any. I was trying to think of what is the actual reason and that’s the first time I’d ever had reason to dig into this, to what we call drill down on this stuff. I remember talking to my research guy and it dawned on me, I said, “Look, if we buy treasury securities from the Fed or we buy treasury securities from the Treasury, it doesn’t matter to us in the private sector.” The money goes to the same place, the Fed, we own the same thing which is a securities account at the Fed, we’ve got money in a savings account at the Fed. If it doesn’t matter to us, it can’t matter to the economy. Any differences has to just be accounting on their side of the ledger.

Yet, if the Fed’s doing it it’s for monetary purposes to hit their interest rate targets – it’s called a reserve drain. If the Treasury’s selling the, it’s the fund expenditures. It’s either one or the other, so obviously it was just a big reserve bank, because when you sell securities dollars shift from reserve accounts to the securities accounts, whether it’s the Treasury or the Fed, it doesn’t matter and it reduces dollars in reserve accounts, which is called a reserve drain, that’s how they refer to it.

The consequence of that is it changes the overnight interest rate and so what the Fed does is what’s called offsetting operating factors, and if the Treasury’s doing these reserve drains, selling securities, the Fed’s offsetting them doing repo and reverse repo and all kinds of other things, which they call offsetting operating factors which includes offsetting the float, things that haven’t cleared yet, cheques in circulation. It’s all to keep the reserve market in balance for the further purpose of hitting your interest rate targets, that’s how they used to do it back then.

All of a sudden, this whole $3 trillion debt, which is what it was back then I think, is just a big reserve drain, it’s got nothing to do with funding expenditures or financing to government. And in fact, as they say in the Fed, you can’t do a reserve drain without doing a reserve add, they’ve got to spend first – they spend the money first and then it’s allocated either to reserve accounts or securities accounts, depending on their reserve management techniques. So the reason there’s no risk of default is because payment is just simply a matter of the Fed crediting the member bank account unless they’re going to get an electric shock or something when they try and do it, there’s no operational reason to default on anything.


Alan Kohler:

You had an insight in the early 90s that this is what would happen in Italy?

Mosler:

Yeah, they had a floating exchange rate, same thing. One of our clients was Harvard Management and we all wanted to now put all these bonds in and they said, “Well, we’ve got connections, let’s go over and talk to the people in Italy to make sure they know which buttons to push so they don’t accidentally decide not to pay when all they have to do is push a button to pay.” So we said, “Fine, that’s good.” We went over there and it was a pretty dramatic trip and we wound up in the office of Luigi Spaventa who was of the Treasury back then and I think he was Assistant Treasury Secretary or Treasury Secretary. I asked him, I just said rhetorically, “Professor, why is Italy selling all these BTPs and CCTs, all these bonds?” He said, “To fund expenditures.”

“Or is it because if you did sell these securities, if you just spent the Lira and did sell securities, the overnight rate would fall from your target rate of 12 per cent or 11, whatever it was, to zero?” And he looks up and he thinks for a minute, he goes, “No, it wouldn’t fall to zero, it would only fall to half because we pay half a percentage just on reserves over here.” When he said, I knew he got it. About two or three seconds later, he jumps up and he goes into this rage against the IMF, “You’re making us act procyclical for nothing!” He was just livid. We were supposed to be there for a 20 minute meeting. He starts calling in people from the other offices and it went from like doomsday – everywhere we went to was like doomsday – to a celebration.

They were making us cappuccino and everybody’s smiling, we’re all talking about how it’s just a reserve drain, you’re always going to make your payments, there is no crisis. Then a couple of days later, the news came out of Treasury in Italy, “No extraordinary measures would be taken, all payments would be met on time.” And we had good returns on our Italian bonds, we were the largest holders outside of Italy at the time.


Alan Kohler:

Right, and you made 2 per cent carry?

Mosler:

We made 2 per cent, yeah, and it was on billions – we probably had $10 billion worth of Italian Lira because we didn’t have to put up any money, we borrowed all the Lira to pay for it and back then the leverage was huge that you were allowed to do.


Alan Kohler:

Did all that come to an end when they created the Euro at the end of the 90s?

Mosler:

Yeah, there were no more Lira. I held a conference in 1996 with Bretton Woods and we had a lot of central banks and I remember Charles Goodhart was there and Bernard Connolly was there and we had a lot of economists from the street and we talked exactly about – the whole point was to outline to everybody exactly what was going to happen in this European thing when they locked the currencies – not even when they went to the Euro but just when they were locked, which was I think two years before they – maybe ’98, they were locked, and then they switched over in 2001. That was all the European member nations were going to become like the US states. The central bank is like the Fed and suddenly Bank of Italy is just a regional Fed, like the Fed Atlanta or something like that.

And so, if you look at the debt ratios in the US states, if they get up to 10 per cent of GDP, they’re in trouble, they’re in a crisis. California gets in a crisis at 5 per cent, right? If it’s not your currency in your central bank, if you’re a state or local government or emerging market in dollars, it’s all the same thing. Your debt limits are much, much lower than if it’s your own currency. So here you have these countries that have debt to GDP ratios of 70 per cent, 80 per cent, 125 per cent, all waltzing into this union where all of a sudden they’re US states that can’t survive financially with over 10 or 15 per cent at the most. One of them hadn’t had their own currency, I think it was maybe Luxembourg or Belgium – I think Belgium had the French Franc, one of them didn’t have their own currency and their debt ratio is 10 or 15 per cent, which is all you can do if you don’t have your own currency, all the others were high. They just walked into this meat grinder, right, with debt ratios that were absurd given their new status and it’s just a matter of time before…

And then all the bank deposit insurance was guaranteed by the member nations so they wouldn’t have to cover each other’s backs. That’s like California insuring Bank of America, how long would that last in a crisis? If New York was insuring Citibank or something like that, they’d both go down and that doesn’t work. It’s got to be the Federal Government, it’s got to be the FDIC where they can just write whatever cheque is necessary, it’s no consequence from a solvency point of view. It’s like, how can these guys who have no credibility, they’re not credible on their own, do debt ratios served for the new status, then be the insurance for the banking system – this is nuts. The first banking crisis that hits is going to take this whole thing down, and that’s what happened.

Then Draga came in and had to say, “We’ll do what it takes to prevent the fall.” Which meant central bank guarantee and now, since then, as long as they stay under the central bank umbrella and behave themselves fiscally, fall in line, their bonds all trade at the policy rate and the only reason they have any spread is because of the risk that they step out of line.


Alan Kohler:

Tell us how your ideas and modern monetary theory, in general, applies to the pandemic that we’re in now?

Mosler:

What we have, started off as and is still there, a massive labour supply shock. Why are people out of work? Because it’s too dangerous to go to work. That’s a lot different than having just a lack of aggregate demand or something like that. if you look at what’s happened in the US, the personal income’s actually gone way up. Now, ex-government assistance it’s gone down, but with all the government assistance, the unemployment, the extra government – employment insurance for $1,200 cheques and everything else, the PPP, the personal income rose a lot. It didn’t fall as would normally happen in a recession and consumption went down even though income went up.

I mean, you never see that happen. We’re in this massive labour supply shock and the reason consumption goes down is because you’ve got 35 million people out of work and basically in the service industry and those services aren’t available, you can’t get a haircut, you can’t go to a restaurant. And so, consumption is down but income’s there. It’s something that hasn’t happened before and it’s not recognised for that. It carries its own risks and prescriptions that aren’t being discussed, I don’t think, and are not capable of discussion, so I’m not sure how this is going to end.

But it could just wind down and not be a problem and it could be some kind of inflationary disaster, you just keep sustaining income without any supply side, at some point you could get excess demand. We’re not there yet, because people are petrified and are not spending their income – you see the savings rate is going up. People aren’t borrowing for cars and houses like they were, so consumer credit, everything has collapsed because they’re not using their credit cards, they’re not borrowing. So far, so good, supply and demand are sort of in balance and it’s reasonably stable in that sense, but real output’s collapsed and it’ll come back a little bit but still at depression levels.


Alan Kohler:

I guess the problem is that the only thing the government can do, really, is to provide money into the economy. It can’t create employment, it can’t actually put people to work and provide the services or at least enable the services to be provided.

Mosler:

Well, maybe it could, maybe it could facilitate some way to get these things done in a safe way, like everybody wears a mask. Except we have a President who was totally against it and the infection got totally out of hand, right? Absurdly out of hand. It was their responsibility to make it safe to go to work again and they couldn’t figure out a way to do that and they still haven’t, and come up with ways that you can work from home let’s say that were somewhat unique or some things you could do to provide the real output and services that people want without endangering your health. They haven’t looked at that at all.

There’s nobody out there that’s saying, “Okay, we’ll have a mobile barber shop and it’ll park out the front of your house and you can go out and get a haircut and it’ll all be sprayed and you’ll be okay.” And it’s going to be more expensive for a haircut to do that, but at least it’ll bring back some of the services that we’ve lost.


Alan Kohler:

That’s true – sorry, before you get onto the other thing – it is interesting, as you say, that what the government has done is actually shut down the restaurants and prevented people travelling. It hasn’t actually said, “What we’re going to do is find a way for the restaurants to operate…” as governments to facilitate those things continually.

Mosler:

Yeah, and you have to do both, right? The initial thing is to shut them down, but then what you want to do is figure out a way to do it safely. The other thing is, look at the energy consumption drop dramatically, right? Gasoline consumption dropped, emissions dropped. Suddenly we have the best air quality we’ve ever had, and what did we eliminate? All we eliminated were non-essentials, right? And so, wow, you talk about a conservation effort. Here, we eliminated non-essentials and we’ve achieved all these environmental goals that weren’t supposed to happen for 20 years or whatever the projections were. The CO2 is not going up anymore, nobody’s talking about that. But we’re trying to restart the economy and get back to old levels of emissions, it’s like what’s that all about?

Haven’t we achieved our goals, now don’t we want to look at ways to resume consumption, which is spending of dollars on things that don’t burn things that create problems and don’t create all this environmental destruction? But you don’t see any of that either. To me, there’s a massive leadership vacuum and a massive opportunity is being squandered to redirect things the way… I remember after 9/11 and the economy kind of shutdown, people were going to church instead of going to shopping and I’m thinking, this is a good thing. It’s a big move away from materialism, people are more concerned about family and values, they’re rethinking their lives, we should encourage this rather than head us back on this other path of materialism.

The President, it was Bush at the time, gets up and he says, “We’ve got to get out of church and get back into malls to get the economy going.” It’s like, no! [Laughs] It’s happening again.


Alan Kohler:

It’s interesting you said that the disaster scenario that you see from the pandemic is inflation?

Mosler:

It’s a possibility, yeah. Or you could get a highly deflationary thing, because the supply side on these essentials is apparently easy to sustain and you don’t eat more food because you can’t get a haircut, you don’t say, “Okay, I now have extra money so I’m going to eat more.” So a lot of these essentials that we’re buying, the quantity consumed doesn’t go up just because you have more money. We’re updating inflation pressures on those types of things. You get inflation pressures on other things, but not on those. There is some point, I’m sure, that the government throws enough money out there – if they gave everybody a billion dollars, clearly you’d have a massive redefining of the price level. But the levels they’re doing so far seem to have been well within bounds of any kind of inflationary issue. But it can change quickly, it can change very quickly.


Alan Kohler:

Well, it is partly because, as you say, people are saving their money.

Mosler:

Yeah. They don’t really have a lot to spend it on. Like I said, they’re not going to buy more broccoli because they just got a $1,200 cheque. Have you seen that cartoon where the little boys praying and he goes, “Oh, dear God, please don’t let the cure for COVID be broccoli.” [Laughs]


Alan Kohler:

[Laughs] On that note, we’ll have to end. You’ve been very generous with your time, Warren Mosler, thanks very much.

Mosler:

Check in any time. Thank you.


Alan Kohler:

That was Warren Mosler, one of the founders of modern monetary theory.