Financial topics

[indyboy]

Higgenbotham, As much as I hate the fed and the printing of money (which I think should be illegal), it doesn't matter because society can make immoral to be legal as long you have a pliable congress + president who have the votes to back it up. The current on would be a good example.

Let me go over a few things you said.
1) "My reasoning is that when the economy is in a natural (cyclical) deflationary state, the market will destroy excess money faster than the government or the central bank can create it, no matter how much excess money is created."
2) "In the most abstract sense, it comes down to whether the Fed has a means to pump money into the economy faster than the market can destroy it. "
3) "At some point, the answer to that is no because the market can destroy money almost instantly during a panic but the Fed cannot pump it back in instantly."

Here is what i think about them. Please feel to correct since I have some half-baked knowledge of economics.
(1) does not make sense to me because printing money does not involve cutting trees. It is digital money. You can make 10 trillion in one second if you wanted.
(2) does not make sense. Maybe the Fed cannot pump money if things are all crashing in one day, but given the luxury of 6 months, the Fed can continue to buy things with the new printed money and thereby pump cash into the economy. Are you saying that Fed cannot buy things quickly enough ? I think it can buy all the junk over-priced securities out there in no time because all the people who have these securities would love to get it off their books.
(2) does make sense only if the Fed is trying to pump money by keeping interest low. In this case, as John X has pointed out, low interest rate is no good if no one wants to borrow. Maybe this was the monetary policy in Japan which caused deflation inspite of 0% short interest rate. However, this does not apply if the Fed is actively buying stuff with the printed money and pumping cash into the economy. It seems to my simple mind that this may not have been done before because it was considered "wrong". However, with euphemisms like "quantitative easing", everything goes.
Again (3) makes sense to me if the market fell 1000 points in a day. However, given time (and time is on Fed's side now), Fed can pump money in.

Overall, I have stayed out of the markets since early 2008 when I figured the housing crash was coming. However, I did not understand the funny money business at that time. It is my current understanding that I made a mistake over the last year (I should have gotten back into the market) because I did not understand that the Fed can put money into circulation not only by keeping interest rates low, but also by actively buying stuff. If that is the case, all the folks predicting deflation would be wrong and traders like TJ Rogers who are predicting inflation of the Fed printing money are right.

Any input is welcome.
Indyboy.

[wvbill]

Higgenbotham, As much as I hate the fed and the printing of money (which I think should be illegal), it doesn't matter because society can make immoral to be legal as long you have a pliable congress + president who have the votes to back it up. The current on would be a good example.


Here is what i think about them. Please feel to correct since I have some half-baked knowledge of economics.
(1) does not make sense to me because printing money does not involve cutting trees. It is digital money. You can make 10 trillion in one second if you wanted.
(2) does not make sense. Maybe the Fed cannot pump money if things are all crashing in one day, but given the luxury of 6 months, the Fed can continue to buy things with the new printed money and thereby pump cash into the economy. Are you saying that Fed cannot buy things quickly enough ? I think it can buy all the junk over-priced securities out there in no time because all the people who have these securities would love to get it off their books.
(2) does make sense only if the Fed is trying to pump money by keeping interest low. In this case, as John X has pointed out, low interest rate is no good if no one wants to borrow. Maybe this was the monetary policy in Japan which caused deflation inspite of 0% short interest rate. However, this does not apply if the Fed is actively buying stuff with the printed money and pumping cash into the economy. It seems to my simple mind that this may not have been done before because it was considered "wrong". However, with euphemisms like "quantitative easing", everything goes.
Again (3) makes sense to me if the market fell 1000 points in a day. However, given time (and time is on Fed's side now), Fed can pump money in.

...

Any input is welcome.
Indyboy.

I am a novice in these areas, but I will express my understanding:

The real inflation comes from Bank lending since they can multiply by 10 the amount due to fractional reserve lending. But, the banks are not lending and even if they were there would be a shortage of qualified borrowers.

The point is that the money must get lent into the system and then spent into the economy. This is not happening. The Fed for the most part is just swapping existing debt (onto the taxpayer) -- not creating new debt.

Therefore defaults, bankruptcies, fall in asset prices, etc. is destroying money faster than it can be created and that is deflation.

An extreme example: suppose I create a billion dollars, but then put it under my mattress... It has no effect since it did not get into the real economy.

The Fed and Gov want the consumer to borrow and spend in order to combat the deflation, but they are not going to do it. Deflation must continue until the excess debt is destroyed. More debt cannot solve the problem.

The Fed/Gov would like to inflate the debt away over time. But, the numbers are just to big and the problem to widespread -- Worldwide.

My modest understanding...

Bill

[Higgenbotham]

Here is what i think about them. Please feel to correct since I have some half-baked knowledge of economics.
(1) does not make sense to me because printing money does not involve cutting trees. It is digital money. You can make 10 trillion in one second if you wanted.
(2) does not make sense. Maybe the Fed cannot pump money if things are all crashing in one day, but given the luxury of 6 months, the Fed can continue to buy things with the new printed money and thereby pump cash into the economy. Are you saying that Fed cannot buy things quickly enough ? I think it can buy all the junk over-priced securities out there in no time because all the people who have these securities would love to get it off their books.
(2) does make sense only if the Fed is trying to pump money by keeping interest low. In this case, as John X has pointed out, low interest rate is no good if no one wants to borrow. Maybe this was the monetary policy in Japan which caused deflation inspite of 0% short interest rate. However, this does not apply if the Fed is actively buying stuff with the printed money and pumping cash into the economy. It seems to my simple mind that this may not have been done before because it was considered "wrong". However, with euphemisms like "quantitative easing", everything goes.
Again (3) makes sense to me if the market fell 1000 points in a day. However, given time (and time is on Fed's side now), Fed can pump money in.

Any input is welcome.
Indyboy.

Let's take some version of the first case you gave. Say the Fed opened a bank account for every person in the United States and wired $1 million into it. It seems obvious that we would get inflation. My argument is that we would not except in a very abstract impractical sense. What would happen instead is that everyone (well, maybe not everyone) would hold onto their goods and refuse to sell them for dollars. The real economy would collapse and a barter economy would develop. Black market money like old silver coins or foreign currency would spring up and be used for exchange instead. In terms of dollars, there would be inflation but once the Fed destroyed confidence by creating this extreme amount of money, it would not have any practical use or value. As a practical matter the Fed has to keep the outright creation of money at a low enough level to prevent the abandonment of the dollar as world reserve currency. That's probably the first threshhold. That level is determined by foreign countries who currently hold dollars as reserves and use dollars in trade. The BRIC countries have already said "enough is enough" and have made plans to abandon the dollar if further debasement occurs. There is debate on whether the BRIC countries can really make good on that threat or not. They probably can't immediately, but they can make our lives pretty miserable in the meantime. If the Fed wanted to push to the point that the dollar is abandoned as world reserve currency and the Fed pursued this strategy domestically, I think they can create inflation once they push enough electronic money into the system to destroy the bond market. Once the bond market is destroyed, then we could end up like Weimar.

In the second case, yes, the Fed is buying things to prop up their value. I gave the example before of oil and gasoline because that has already happened indirectly, but that instance was a bit different and even today there is no agreement on what happened (speculators using "printed money" or real demand being the driver of prices). The case of the mortgage backed securities that the Fed is buying is a relevant and probably better example. Obviously, as you said, the Fed has propped up the value of these securities by creating or borrowing dollars to purchase them. I think they did a little of both. The real basis for the value of these securities is the value of the underlying real estate. This value is based on employment and income (mostly). As the Fed has purchased these securities and artificially inflated their value, the underlying fundamentals of employment and income have continued to deteriorate. A difference between the value of these securities and the actual value absent the intervention has developed. Banks have continued to hold foreclosed real estate off the market and the public has continued to make real estate purchases for a time as this excess money dissipates, as many are unaware or unconvinced that there is enough of a disparity between inflated and fundamental values. At some point, as the inflated values and the fundamental values reach a larger and larger disparity, there will be a panic and real estate prices will crash. This is covered in one of John's in depth articles. But, you're right, since this Fed activity is more limited and less obvious, there will be some inflation in whatever the Fed is targeting for a time (or at least less deflation). However, over time, the market is eventually destroying more money through other channels (and increasing the fundamental disparity between real value and Fed inflated values), rendering the Fed's efforts useless and dangerous. Only when the underlying disparity in fundamentals present in the cyclical deflationary environment (it is necessary that the economy be in a naturally occurring cyclical deflationary state for this to happen) becomes obvious and overwhelming will there at some point be a panic. The more cleverly the disparity is hidden and the greater it is, the more severe and sudden the developing panic will be.

I think I have explained this to the best of my ability. It's almost impossible to be concise. Of course, I don't know the future but this is my general belief as to how it will develop. Approximately the same thing will happen in the stock market.

Any comments are welcome.

[indyboy]

Higgenbotham - In the same writeup you seem to be outlining two completely opposite scenarios. In the first paragraph, you mention a hyperinflation scenario (Weimar-republic scenario) as a result of the Fed minting money. In the second paragraph, you mention of asset prices crashing in spite of the Fed printing money.

Firstly, I am thinking, we can't have both. The prices of the assets I am interested in buying such as eggs, shoes and houses are either going up or going down; cant be both. It may be hard for the Fed to navigate between the two scenarios i.e. it is a hard control system problem but it seems to me to be not impossible. It can print just enough money to keep the prices where they are. If it overshoots (resulting in inflation), it can even sell its assets to go the other way. In the latter scenario it will get fewer dollars then it paid for the asset (e.g it may get only 20cents per dollar of MBS that it purchased). But who cares ? Essentially, the people who held the toxic debt are off the hook. Essentially, the Fed paid the all the debtors as much money as they lost due to falling asset prices and they are happy.

Secondly, people do not care about things like fractional reserve or monetary base and most people do not even know about it. I have a PhD in EE and Physics and I have only a sketchy idea (from reading websites). Point is that if the prices of eggs, shoes and houses are not going to change with respect to the dollar then nobody is going to be complaining. Most people will rejoice that Benanke/Geithner/Obama saved us.

As a Ron Paul supported who has been saying for years "we cannot print our way out of debt" and hating the Fed and hating the fact that my money is backed by nothing, I must say that I am somewhat stumped after going through a more detailed analysis (and running a few other Gedanken experiments in my head). I will try to write it up sometime and see if it makes sense to other folks. But overall here is what I concluded. The system is basically rigged against people like me who bet against the rising prices of assets. Folks who made money on the rising prices of assets will get to keep their inflated assets at the current inflated price which will become the "right" price in due time if Bernanke has his way and relative to these folks I will be poorer. I may not like it, but there are enough of these people (and, hence, votes) to keep the current government structure in place.


Overall, I like the arguments that John X has put forward in his website and I understand the generational theory (although I feel the time scales are a little bit more elastic than he makes it out to be). However, this whole experiment on QE has never been carried out in this scale before in my opinion. Maybe, this time, it IS different. I hope someone can find a really big hole in what I am saying

[Higgenbotham]

Higgenbotham - In the same writeup you seem to be outlining two completely opposite scenarios. In the first paragraph, you mention a hyperinflation scenario (Weimar-republic scenario) as a result of the Fed minting money. In the second paragraph, you mention of asset prices crashing in spite of the Fed printing money.

Firstly, I am thinking, we can't have both. The prices of the assets I am interested in buying such as eggs, shoes and houses are either going up or going down; cant be both. It may be hard for the Fed to navigate between the two scenarios i.e. it is a hard control system problem but it seems to me to be not impossible. It can print just enough money to keep the prices where they are. If it overshoots (resulting in inflation), it can even sell its assets to go the other way. In the latter scenario it will get fewer dollars then it paid for the asset (e.g it may get only 20cents per dollar of MBS that it purchased). But who cares ? Essentially, the people who held the toxic debt are off the hook. Essentially, the Fed paid the all the debtors as much money as they lost due to falling asset prices and they are happy.

You hit a key point and I was in the process of explaining that, as I could see that my response was unclear in that regard. So I had put it up above, then cut it out when your response came up.

The reference to Weimar is to show the steps that would be necessary to theoretically get to approximately that, however unlikely they are. First, the Fed would have to create a situation where the rest of the world rejects the dollar for international trade, but the dollar still stays in use domestically. I think that's possible to do. After doing that, the Fed would then need to push enough electronic money into the system to destroy the bond market. Only after doing those 2 things could we get to the Weimar scenario.

The first part of that paragraph describes what would happen if the Fed were to obviously push a huge excess of electronic money into the system. In my opinion, the market would instantly reject it, and the world economy would collapse. So that's a separate thing from the Weimar scenario and much more devastating. We could talk more about how that scenario could develop, but it would probably start with a foreign government obtaining intelligence in advance that this is going to happen, then selling their bonds to be first out the door, converting the proceeds to some other currency or to gold, then stopping all shipments of goods to the US unless alternative non dollar payment arrangements are made.

The second paragraph where I described the Fed MBS purchases gets to your point about moving the right amount of money into the system. This is in my opinion what the Fed is trying to do; however, this "disparity" I am talking about refers to the fact that the Fed is unable to target all aspects of the economy equally. While they may be able to hold security prices constant with the right amount of money, they are unable to hold, for example, the underlying wage structure constant which ultimately supports the prices of the securities. As a result, the market waits with baited breath for every weekly unemployment claims report and monthly employment report and dissects the numbers looking for signs of improvement.

[John]

This is an interesting discussion on inflation vs deflation, and I'd
like to add my 2¢.

I've always considered the inflation rate to be somewhat mysterious.
I think the reason is that almost everyone believes that the
inflation rate depends completely on the policies of the central bank
(the Fed). Every time I see something written about the "gold
standard," or "fiat currency" or the "Austrian school," that's the
underlying assumption.

I've come to believe that that underlying assumption is completely
wrong. Of course the central bank has some control over the amount
of money in circulation, but as we know from economics, the inflation
rate depends on two factors: The amount of money in circulation, and
the velocity of money. And Higgie, you've been giving some scenarios
related to the lower velocity of money.

The point is that the central bank has no control whatsoever over the
velocity factor. And I believe that the velocity of money is the
dominating factor in the inflation result, and that the velocity of
money follows a generational pattern.

I'd like to point out that there's another side to the coin.
Economists have keyed off the phrase "Great Depression of the 1930s"
to refer to the "Great Inflation of the 1970s," because by the end of
the 1970s, the inflation rate was over 10% per year.

Paul Volcker, who became Fed chairman in 1981, and who is currently
President Obama's economic adviser, is being lauded as the man who
broke the back of inflation by raising interest rates.

Now, I can't prove this, but I believe that if you take your
analysis, Higgie, and apply it to the 1970s, you can also get an
explanation for the Great Inflation. The hyperinflation of the late
1970s is the mirror image of the deflationary spiral of today.

In the 1970s, all the millions of businesses that had been created
out the Depression were in full bloom, creating a huge demand for
employees, resulting in wage inflation and a high velocity of money,
causing general inflation. That trend ended in the 1980s, and
Volcker had nothing to do with it, any more than Bernanke can control
the deflationary spiral today.

In the 2000s, all of those businesses have become old and
inefficient. This is what I used to call the "Crusty Old Bureaucracy
Theory." I got the idea for this when I heard a television business
news story that described some company as having financial troubles
because the "crusty old bureaucracy" that was running the company was
moving too slowly keep the company competitive with newer upstarts.

All of this has to be tied together with the risk-aversion of the
Great Depression survivors causing the Great Inflation of the 1970s,
contrasted to the debauched use of credit by the Boomers and Xers,
creating a huge bubble, and then a deflationary spiral.

John

[indyboy]

The second paragraph where I described the Fed MBS purchases gets to your point about moving the right amount of money into the system. This is in my opinion what the Fed is trying to do; however, this "disparity" I am talking about refers to the fact that the Fed is unable to target all aspects of the economy equally. While they may be able to hold security prices constant with the right amount of money, they are unable to hold, for example, the underlying wage structure constant which ultimately supports the prices of the securities. As a result, the market waits with baited breath for every weekly unemployment claims report and monthly employment report and dissects the numbers looking for signs of improvement.

Your statement of the "Fed is unable to target all aspects of the economy equally" is basically saying that the economy has so many pieces that it is hard for the Fed to control all pieces. That is what I meant by this being a hard "control-system" problem. However, consider a thought experiment. The root of all the current economic mess are all these people who bought assets and now their assets are under water. Doesn't matter if it is a house, or MBS. The person paid one dollar for it, but now it is worth only 30 cents. So the Fed buys it from him from one dollar (so he remains a happy camper). This is not different than forgiving him or paying him for the amount that he is underwater. What if the Fed could do this with all parties in debt ? Again set morality or illegality aside (we all know we are way past that point). Actually, you can include all the people with credit cards. Fed finds a way to forvgive their debt at any instant by giving them as much money as they owe (it would have to do this instantaneously without prior knowledge because the knowledge that the Fed will forgive debt will cause everyone to buy lots of stuff in advance ).

So now we are in a situation where there are no folks sitting on bad debt resulting from their assets being underwater. Is their a problem now ? I dont see it. It seems to me that the only problem is that of morality because the only people who get nothing are those who are in cash whereas all the people who count their net worth to be = cash + assets-that-are-market-valued suddenly become richer because their debt on their assets (such as house being underwater) is being forgiven. The current administration + the Fed is trying to really achieve this hand in hand without raising hue and cry.

The only other problem is if dollars are being minted to counteract deflation but not euros (so the number of euros in the world is falling due to deflation in assets marked by euros). In this case, prices are being held constant with respect to the dollar (Bernanke makes sure there is no deflation) but falls with respect to the Euro. In effect, the euro is becoming stronger with respect to the dollar (that is what happens when one country's central bank reduces interest rates while all others hold constant) which isnt good for the US because the exports become uncompetitive. Now I kind of understand what these rogues (Geithner/Bernanke and Co.) meant by saying that the central banks need to have a "concerted" effort to "solve" this problem. What he meant was that all of us central-bankers need to print money at approximately the same rate so we keep the exchange rates constant and not rock the boat.

Indyboy.

[wvbill]

Higgie and Indyboy,

Some interesting comments and insights -- you are getting beyond me...

I will make one point, which I feel is necessary to keep in mind for a proper perspective:

The Fed (and all the central banks) is a private Banking cartel whose purpose is to transfer wealth to themselves and their share holders. And, they are doing an excellent job of that.

My point is: don't assume that they even care to save the country or the economy. Some speculate that, when the time is right, they may even trigger the collapse. That's when they can really get the wealth -- use all the money they have stolen to buy up all the real assets at bargain prices.

These people are greed plus evil incarnate -- I don't know their plan -- but, I think they have one, and at may well be beyond the ability of reasonable decent people to imagine.

Sorry, if this has turned into a rant.

I will continue to read your posts with interest.

Bill

[Higgenbotham]

Your statement of the "Fed is unable to target all aspects of the economy equally" is basically saying that the economy has so many pieces that it is hard for the Fed to control all pieces. That is what I meant by this being a hard "control-system" problem. However, consider a thought experiment. The root of all the current economic mess are all these people who bought assets and now their assets are under water. Doesn't matter if it is a house, or MBS. The person paid one dollar for it, but now it is worth only 30 cents. So the Fed buys it from him from one dollar (so he remains a happy camper). This is not different than forgiving him or paying him for the amount that he is underwater. What if the Fed could do this with all parties in debt ? Again set morality or illegality aside (we all know we are way past that point). Actually, you can include all the people with credit cards. Fed finds a way to forvgive their debt at any instant by giving them as much money as they owe (it would have to do this instantaneously without prior knowledge because the knowledge that the Fed will forgive debt will cause everyone to buy lots of stuff in advance ).

So now we are in a situation where there are no folks sitting on bad debt resulting from their assets being underwater. Is their a problem now ? I dont see it. It seems to me that the only problem is that of morality because the only people who get nothing are those who are in cash whereas all the people who count their net worth to be = cash + assets-that-are-market-valued suddenly become richer because their debt on their assets (such as house being underwater) is being forgiven. The current administration + the Fed is trying to really achieve this hand in hand without raising hue and cry.

Indyboy.

I think I understand the question, but let's be sure first.

"Fed finds a way to forvgive their debt at any instant by giving them as much money as they owe. "

You mean that the Fed will create the money out of thin air that is necessary to pay off all debts. It would be all debts, not just the delinquent or underwater loans. I'm also assuming the money would be paid back to the creditor and the debt extinguished. For example, if a person had a mortgage with ABC Mortgage Company with a balance of $100,000 the Fed would give the $100,000 to ABC Mortgage Company and the person would then own their house free and clear. The same would apply to all auto, student, credit card, business, etc., loans.

Is this correct?

[indyboy]

In the 1970s, all the millions of businesses that had been created
out the Depression were in full bloom, creating a huge demand for
employees, resulting in wage inflation and a high velocity of money,
causing general inflation.
John

John, without any comment on the rest of your passage (my limited understanding of inflation being a little different than yours, I can write that separately) I am not sure of this statement. It seems to me that you are saying that 1970's were a period of high business growth which fueled shortage of labor and hence, wage-inflation. If so then 70's would be inflationary+growth where I believe that most people think of 70s as being inflationary+recessionary. Actually, post oil-shock, when the inflation really kicked in the unemployment rate was actually quite high. Briefly, I look upon prices as being the demand-supply equilibrium between available money (monetary-base + money created by our fractional reserve system) and the goods it is chasing. So inflation can happen if the same the same amount of money is chasing fewer amount of goods and in the 70's less oil was a big factor.

Indyboy