14-Jun-11 News -- Revisiting the 'Principle of Maximum Ruin'

Discussion of Web Log and Analysis topics from the Generational Dynamics web site.
John
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14-Jun-11 News -- Revisiting the 'Principle of Maximum Ruin'

Postby John » Mon Jun 13, 2011 11:35 pm

14-Jun-11 News -- Revisiting the 'Principle of Maximum Ruin'

Economics of the Maginot Line

** 14-Jun-11 News -- Revisiting the 'Principle of Maximum Ruin'
** http://www.generationaldynamics.com/cgi-bin/D.PL?xct=gd.e110614b#e110614b



** 14-Jun-11 World View -- Vietnam escalates South China Sea dispute with China
** http://www.generationaldynamics.com/cgi-bin/D.PL?xct=gd.e110614#e110614




Contents:
"Revisiting the 'Principle of Maximum Ruin'"
"Economics of the Maginot Line"
"Steve Keen's 'Credit Accelerator'"

### World View - Vietnam escalates South China Sea dispute with China
"Vietnam escalates South China Sea dispute with China"
"Vietnam reduces imports of China's fruits and vegetables"
"Va. Senator Jim Webb urges U.S. action in South China Sea dispute"
"Riot police rush to quell migrant worker riot in southern China"
"Germany Gives Diplomatic Recognition to Libyan Rebels"
"Who tried to kill Yemen's president Saleh?"
"Greece looks increasingly likely to default"
"US reacts to Lebanon's new government, dominated by Hizbollah"

Keys:
Generational Dynamics, Bruce Berkowitz, Kenneth Heebner,
Ben Miller, Principle of Maximum Ruin, Steve Keen,
Maginot Line

Keys:
Generational Dynamics, Vietnam, Hanoi, China,
South China Sea, Jim Webb, Germany, Libya,
Transitional National Council,
Ali Abdullah Saleh, Ali Mohsen al-Ahmar,
S&P, Greece, Lebanon, Hizbollah

Veitiesty

Thanks for the opportunity

Postby Veitiesty » Tue Jun 14, 2011 5:08 am

Thanks for the oportunity to hang out on here and learn some stuff I never heard of generationaldynamics.com before.

DCMark

Re: 14-Jun-11 News -- Revisiting the 'Principle of Maximum R

Postby DCMark » Tue Jun 14, 2011 2:58 pm

Great points John. I think there is a lot of merit to Steve Keen's PDF you linked to. Repealing Glass-Steagall created a monster.

I forwarded that link to someone who writes speeches for Bernanke & helps set Fed monetary policy. I also summarized the arguments that private debt was propping up asset bubbles. I thought you might be interested in the response to get some insight into Fed logic:

"I wasn't talking about financial assets. I was simply pointing out that for global real commodities--such as oil, other industrials, and foods--supply and demand matter. From time to time, arguments about speculation come up, but that's not been the case in recent years. With global demand rising as emerging economies develop, the relative price of these goods will increase and over time, as has been the case for oil, we will find ways to conserve and be more efficient. The relative price change does raise inflation temporarily, but to tighten monetary policy in order to offset that increase with price constraint elsewhere is not the answer.

As your blog argues, the liquidity needs to be turned into deposits and loans. Bank credit has been declining since 2008.

Listen to Gov. Duke--a banker:

'One concern that has been raised about asset purchases is the resulting expansion of the Fed's balance sheet and the corresponding increase in reserves. For example, some observers have noted that an increase in reserve balances could lead to an increase in the money supply, which would in turn generate inflation pressures. Others have worried that elevated levels of reserve balances might make it difficult for the Federal Reserve to remove monetary accommodation at the appropriate time. While we will need to remain alert to economic developments, I am convinced that we can and will manage these risks.
The monetary policy objective of asset purchases is to foster downward pressure on interest rates. But assets are "paid for" by crediting the reserve balances of banks, generating higher levels of reserve balances in the banking system. Reserves are relevant to the growth of the money supply because banks are required to hold a percentage of some types of deposits as reserves with the Federal Reserve. Thus, the total amount of reserves in the banking system acts to cap maximum reservable deposits. It is important to note that it is deposits, not reserve balances, that are included in the monetary aggregates used to measure the money supply. For example, M1 is made up of currency, traveler's checks, demand deposits, and other checkable deposits, while M2 is made up of M1 plus savings, small time deposits, and retail money market mutual funds.

Moreover, the linkage between the level of reserve balances and the monetary aggregates in the current environment is quite weak. You were probably taught, as I was, that the broad monetary aggregates increase when reserve balances increase because the larger volume of reserves supports increased lending, which in turn leads to a larger volume of reservable deposits. While that argument might hold in normal circumstances, in the current environment excess reserves are many multiples of required reserves, and adding reserves is unlikely to spark a further increase in the volume of deposits. As a result, the textbook linkage between reserve balances, bank loans, and transaction deposits just is not operative at present. Fundamentally, the levels of M1 and M2 are determined by the strength of the economy and the preferences of businesses and consumers for money, which depend on the yields on monetary instruments and competing assets.

Recent experience has again illustrated the difficulty in identifying a reliable relationship between reserve balances and the monetary aggregates. Even though Federal Reserve actions to fight the financial crisis and support the economic recovery added roughly $1 trillion to a base of about $43 billion in aggregate bank reserves, M1 and M2 rose at relatively moderate rates over the same period.

Going one step further, I should note that the linkage between the monetary aggregates and either real economic activity or inflation has been very weak over recent decades. The lack of a reliable relationship between the monetary aggregates and the economy led the Federal Reserve to abandon M1 as a key policy instrument in the early 1980s and then to reduce the role of M2 as a policy instrument in the late 1980s and early 1990s. Indeed, in a 2006 speech about the historic use of monetary aggregates in setting Federal Reserve policy, Chairman Bernanke pointed out that, "in practice, the difficulty has been that, in the United States, deregulation, financial innovation, and other factors have led to recurrent instability in the relationships between various monetary aggregates and other nominal variables."3 Still, my colleagues and I will be monitoring a wide range of financial and economic developments very closely--including the growth of the money supply, inflation, and many other financial and nonfinancial variables--and, based on a full assessment of those developments, the FOMC will withdraw monetary accommodation at the appropriate time. My view is that the elevated reserve balances would be inflationary only if they prevented the FOMC from effectively removing monetary accommodation by raising interest rates when the time comes to remove such accommodation, and I am convinced that that will not be the case.

The FOMC has a number of tools at its disposal for raising interest rates. When appropriate, the Federal Reserve can put upward pressure on interest rates by raising the rate it pays on reserve balances. Moreover, we have developed new tools that will allow us to drain reserves if necessary. In particular, we can drain large volumes of reserves by replacing them with repurchase agreements and term deposits. Finally, we can always sell the securities we purchased. Such sales would not only drain reserves but would also put direct upward pressure on longer-term rates.' "

Mark again:
Pretty arrogant to think that they can use untested monetary instruments at precisely the right time to tighten policy when needed. Also pretty arrogant to think that asset bubbles are purely a matter of limited supply and greedy demand from developing countries when the dollar has been dropping in purchasing power and shifting government regulations (proposed & passed) and monetary policies have created a enormous financial & economic uncertainty, causing anyone with savings to want to hoard their money & find any safe store of valuable possible (thus prolonging the Great Recession).

SovietofWashington
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Re: 14-Jun-11 News -- Revisiting the 'Principle of Maximum R

Postby SovietofWashington » Tue Jun 14, 2011 3:38 pm

Keen is one of the few economists that deserve regular reading (weekly or bi-weekly would be sufficient given his posting rate) since he really gets it. He's with you, John in predicting a grinding deflation as the most likely outcome of the GFC.

His article from 2009 entitled The Roving Cavaliers of Credit (http://www.debtdeflation.com/blogs/2009 ... sofcredit/) is a good read as well.

John
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Re: 14-Jun-11 News -- Revisiting the 'Principle of Maximum R

Postby John » Wed Jun 15, 2011 10:51 am

SovietofWashington wrote:> Keen is one of the few economists that deserve regular reading
> (weekly or bi-weekly would be sufficient given his posting rate)
> since he really gets it. He's with you, John in predicting a
> grinding deflation as the most likely outcome of the GFC.

> His article from 2009 entitled The Roving Cavaliers of Credit
> (http://www.debtdeflation.com/blogs/2009 ... sofcredit/)
> read as well.


Thanks for the reference. It's interesting that Marx made the same
observations for the Panic of 1857, an earlier generational financial
crisis.

DCMark wrote:> Great points John. I think there is a lot of merit to Steve Keen's
> PDF you linked to. Repealing Glass-Steagall created a monster.

> I forwarded that link to someone who writes speeches for Bernanke
> & helps set Fed monetary policy. I also summarized the arguments
> that private debt was propping up asset bubbles. I thought you
> might be interested in the response to get some insight into Fed
> logic:

> "I wasn't talking about financial assets. I was simply pointing
> out that for global real commodities--such as oil, other
> industrials, and foods--supply and demand matter. From time to
> time, arguments about speculation come up, but that's not been the
> case in recent years. With global demand rising as emerging
> economies develop, the relative price of these goods will increase
> and over time, as has been the case for oil, we will find ways to
> conserve and be more efficient. The relative price change does
> raise inflation temporarily, but to tighten monetary policy in
> order to offset that increase with price constraint elsewhere is
> not the answer."


Thanks for getting a Fed response. That's really interesting.

But here's the question I always ask myself in situations like
this: Suppose that the person you wrote to agrees that we're headed
for a major stock market panic and crash, and a big financial
crisis. What would he say?

Well, he can't admit that, so he'd say exactly what he did say. In
other words, what he says tells us absolutely nothing about what
he believes. What he says is a political construct designed to
fit any situation.

When EU officials were caught in a series of major lies about Greece,
Eurogroup chairman Jean-Claude Juncker was quoted as saying, "When it
becomes serious, you have to lie," as I reported a few weeks ago.
There's absolutely no doubt in my mind that Fed officials have the
same philosophy. So the answer that you got is interesting, but
it's highly doubtful that it bears any relationship whatsoever
to what's really going on.

John

vincecate
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Re: 14-Jun-11 News -- Revisiting the 'Principle of Maximum R

Postby vincecate » Thu Jun 16, 2011 7:03 am

DCMark Fed Friend wrote: It is important to note that it is deposits, not reserve balances, that are included in the monetary aggregates used to measure the money supply. For example, M1 is made up of currency, traveler's checks, demand deposits, and other checkable deposits, while M2 is made up of M1 plus savings, small time deposits, and retail money market mutual funds.


Wow. I never noticed this. This is true and yet so wrong. Any bank can withdraw its "excess reserves" from the Fed at any time and get physical paper money. So it is wrong to count paper money as any different from excess reserves. Yet I checked and while "monetary base" does correctly include "excess reserves" the M1 and M2 do not. I had thought M1 and M2 were supersets of monetary base (which they should be).

http://en.wikipedia.org/wiki/Money_supply

This is effectively a loophole in the money supply definition that the Fed can hide trillions of dollars in. Ouch.

Personally I think the right way to view this is that the Fed and the government are in the same box. If the Fed is paying interest on "excess reserves" it is the same as the Treasury paying interest on bonds. It is really a way to keep money out of circulation so it does not contribute to inflation.

DCMark Fed Friend wrote: My view is that the elevated reserve balances would be inflationary only if they prevented the FOMC from effectively removing monetary accommodation by raising interest rates when the time comes to remove such accommodation, and I am convinced that that will not be the case.

The FOMC has a number of tools at its disposal for raising interest rates.


If the Fed were operating in a vacuum this would be true enough. The problem is that the government makes the laws and controls which people are running the Fed. The government has $14+ trillion in debt and a 10% interest rate would mean all tax money just covered interest on the debt. This would make it obvious to everyone that they were broke and would have to print like crazy. So the government can not handle high interest rates. So the Fed will be "prevented from removing monetary accommodation by raising interest rates". And the Fed will print like crazy.

As long as interest rates were going down people liked to own bonds because the price of bonds goes up as the interest rate goes down. But after getting to near zero, and printing a few trillion new dollars or reserves, I am rather confident that interest rates will be going up and people will not be wanting to hold bonds. This will be called a "bond revolt" or "attack of the bond vigilanties" but really it is just foolish to own bonds at this point. The Fed will be the only buyer of bonds and the government will insist that they buy all the government needs them to buy. This is the way it always end up working historically. The rules go out the window.

The core problem is who is going to give the government over $100 billion per month to cover the deficit? At 1.5% for 5 years only a fool would do it. It is hard to find $100 billion worth of fools every month. So interest rates have to go way up (in which case gov clearly broke and nobody loans them money except the Fed) or the Fed prints like crazy and nobody else buys gov debt. People act like the Fed is all powerful, but really the government has the power. They make the laws, they have the guns. They will get their extra $100 billion a month somehow.

The deflation Marx was looking at in the 1800s crisis was under a gold standard. Nobody ever gets big deflation under fiat money as the government would always be happy to have an excuse to print and spend more money.


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