Softpanorama

May the source be with you, but remember the KISS principle ;-)
Contents Bulletin Scripting in shell and Perl Network troubleshooting History Humor

Fiat money, gold and petrodollar

News Casino Capitalism Recommended Links Petrodollar Money as conserved demand Pushing on the string Fiat money and Fractional Reserve Banking
Gold Inflation, Deflation and Confiscation Neoliberalism as a New Form of Corporatism Neocolonialism as Financial Imperialism Why Peak Oil Threatens the International Monetary System  Economics of Peak Energy Why Peak Oil Threatens the International Monetary System
Neoliberal Brainwashing: Journalism in the Service of the Powerful Few War is a Racket - Incredible Essay by General Smedley Butler Ron Paul War and Peace Quotes Corporatism quotes Humor Etc
energyecon:

Mary wrote:

Money has no intrinsic value. Its value is extrinsic, comparative.

Now don't upset the bigendians (hard money) folks by telling them they are not really different than the littleendians (fiat money) folks... 

Monies – Joining Economic and Legal Perspectivesby David Bholat, Jonathan Grant and Ryland Thomas

Bank Underground

The economist John Kenneth Galbraith once quipped that the answers economists give to the question “what is money?” are usually incoherent. So in this blog we turn to law for some answers. Debate about the nature of money has been renewed by recent financial crises and the rise of digital currencies (Ali et al 2014; Desan 2014; Ryan-Collins et al 2014; Martin 2013). This was the focus of a panel session at the Bank’s recent annual conference on Monetary and Financial Law, which brought together lawyers and economists to develop interdisciplinary perspectives on topics such as money. It prompted us to think more deeply about how law does and does not constitute ‘it.’

Common legal attributes of money

Anything can function as money. And many things have: cattle; cowry shells; even cigarettes. But as Minsky once said, while “everyone can create money, the problem is to get it accepted.”

While in theory anything can be money, the reality is few things are. Monies produced by the Royal Mint and the Bank of England (BoE) are the ultimate means of payment, followed by private sector claims, in order of how immediate they provide for full convertibility into these.

Some economists argue that this hierarchy of money is the result of legal privileges, especially legal tender legislation (Smith 1936; Hayek 1976). However, legal tender legislation in the UK only applies to the settlement of debts. It doesn’t cover spot transactions — our daily buying and selling in the marketplace.

So if we want to explain why state issued tokens and claims, and promises of immediate conversion into them, are monies, legal tender laws seem less important than other legal attributes that make them trusted and give people comfort they can get someone else to accept them.

In the past, when gold and silver were monies, economists often explained this reality by reference to these metals’ physical attributes such as portability, uniformity and durability. Today these physical attributes of metal monies have legal analogues.

Think of a fiver. Three legal attributes make it money.

First, a fiver is portable because it is legally negotiable: it can be transferred to others without each time gaining consent from the BoE (the fiver’s issuer), and, once transferred, it’s free and clear of any claims being brought by those who previously possessed it provided it was taken in good faith (Geva 2011).

Second, fivers are uniform because they are fungible: each can substitute for another. This is because the rights and obligations they confer are the same.

Finally, durability means maintaining fixed nominal value through time. A rough legal equivalent of durability is an option for instant par redemption. State-backed monies such as fivers and promises of immediate conversion into them are monies probably because states retain the power to fix the nominal meaning of their unit of account and can choose to accept only claims denominated in that unit of account in discharge of tax obligations.

Monies

While all monies share hues of negotiability, fungibility, and instant par redemption, each type of money also has unique legal features. Ordinarily, these legal differences don’t matter because one type of money is easily convertible into another. Qualitative differences in the legal construction of monies appear, if at all, merely as quantitative differences in their rate of financial return. For example, in ordinary times, although term bank deposits accrue interest and BoE notes do not, they are treated by most people as equivalents. However, during financial crises, qualitative differences reassert themselves and, in the extreme, parity breaks down. In classic bank runs, for example, individuals seek to convert bank balances into cash because the difference between having a claim on a private counterparty that can go bust, versus a public counterparty like central banks that can operate even on negative capital, acquires greater salience.

Consequently legal differences between monies sometimes matter. So we note some below. Here our analysis chimes with research in sociology and behavioural economics showing that money is not singular but plural (Dodd 2014). However, while those studies focus on how money is imbued with different meanings by individuals once in circulation, for example, depending on its source (e.g. whether it’s from wages or inheritance), our point is that monies are plural from the start, in the nature of their legal construction.

Royal Mint coins

Sterling coins are manufactured by the Royal Mint Limited, a public limited company wholly owned by HM Treasury through the Royal Mint Trading Fund. Different denominations of coin are legal tender up to different thresholds. For example, 5p coins are legal tender for any amount not exceeding £5, while 50p coins are legal tender for any amount not exceeding £10. Royal Mint coins are unique among UK monies in that they are not the legal obligations of any counterparty, though they are treated as a liability of central government in the financial accounts of national income statistics.

BoE notes

Legally, notes represent debt obligations of the Bank. Originally they could be redeemed in gold. However, since 1931, the Bank no longer pays out gold against its notes. BoE notes were first issued in the seventeenth century but did not acquire legal tender status in England and Wales until 1833. They are not legal tender in Scotland or Northern Ireland.

BoE reserve accounts

BoE reserve accounts are debt obligations owed by the Bank to commercial banks and other Sterling Monetary Framework (SMF) participants. They are the largest liabilities on the Bank’s balance sheet and have been used by banks for settling their obligations with each other since at least the mid-19th century.

Scottish and Northern Ireland banknotes

Seven banks in Scotland and Northern Ireland issue their own notes which are these banks’ debt obligations. These notes are not legal tender even in Scotland and Northern Ireland. Rather, they circulate by convention, underscoring our thesis about the importance of other legal attributes besides legal tender legislation in conferring ‘money-ness.’ As a result of the Banking Act 2009, these notes are backed in full by a combination of Royal Mint coins, BoE notes and reserve account balances.

Accounts with banks and mutual organisations

Banks and mutual organisations offer current and other types of spendable accounts used for payments. On the one hand, these accounts are unsecured debt obligations of private organisations. On the other hand, many are backed up to certain limits by statutory guarantees. Today the value of transactions involving these accounts greatly exceeds the value of transactions involving legal tender. And growth in these accounts’ balances is mainly driven by additional loans that create equal and opposite accounting entries.

Further research

Economists and lawyers often approach the topic of money differently because they have different philosophies underpinning their professions. Economics is basically a branch of utilitarianism, meaning that the consequences of actions are the basis for judging their rightness or wrongness. Hence many problems in economics are about optimization and involve cost-benefit analysis. By contrast, law is derived from deontology, meaning some actions are intrinsically right or wrong according to normative rules. Hence legal decisions are typically justified by history and notions of justice.

These philosophical differences mean economists and lawyers often think about money differently. For example, many economists think money arose as a transaction cost reducing, utility enhancing device to overcome the absence of a double coincidence of wants that hampers barter, while many lawyers and institutionally minded economists think the origins of money is the state (Goodhart 1998). Economists mostly think of money as a medium of exchange (Kiyotaki and Wright 1989) because this function relates to trade and commerce, while law emphasises money as a means of payment (Proctor 2012): whether one party has discharged their obligation to another. In emphasising the settlement of obligations, law draws attention to money’s role in non-commercial transactions such as taxation and transfers. And while economists treat money mainly as an indicator or intermediate target for influencing real, macroeconomic variables, lawyers typically think about money in the context of individual cases and adhere to the doctrine of nominalism.

Despite these different points of emphasis, this blog has tried to show that understanding money requires joining legal with economic perspectives. For example, while for a long time lawyers saw bank deposits simply as loans, economists much earlier appreciated their wider bearing on inflation and output. However, if economists want to explain why certain claims like bank deposits are money, while others are not, they must look at their legal attributes and socio-legal history. Recent research on money by Bank staff has been informed by both law and economics (McLeay et al. 2014; Bholat 2013). Here are a couple paths on which further interdisciplinary research might advance:

  1. How is the money demand for a claim impacted by changes in its legal constitution, for example, after a major structural break like the conferring of legal tender status on BoE notes or abolition of their gold convertibility?
  2. Besides negotiability, fungibility and instant par redemption, what other legal features make claims suitable to be money?

David Bholat works in the Bank’s Advanced Analytics Division, Jonathan Grant works in the Bank’s Legal Directorate and Ryland Thomas works in the Bank’s Monetary Assessment and Strategy Division.

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.

If you want to get in touch, please email us at bankunderground@bankofengland.co.uk


Top Visited
Switchboard
Latest
Past week
Past month

NEWS CONTENTS

Old News ;-)

[Jun 27, 2017] Inflation and money velocity

Notable quotes:
"... It implies that it is money supply that contributes to inflation. However it is not money supply that contributes to inflation it is income. That is money times the velocity of money ..."
Jun 27, 2017 | economistsview.typepad.com

djb , June 27, 2017 at 02:56 AM

Now I just read an article by some guy with the typical quantitative easing is bad because it just dilutes everyones wealth , debases the currency value and and all that

This is nonsense

It implies that it is money supply that contributes to inflation. However it is not money supply that contributes to inflation it is income. That is money times the velocity of money

and in fact it is not income that contributes to inflation it is income times the propensity to consume of that income

money in bonds is not really actively involved in income except for the interest it's earning

so when the central bank "prints money" and then uses that money to buy bonds all the central bank is doing is exchanging one form of inactive wealth with another form of inactive wealth

that is neither the value of the bond nor the value of the money that the fed printed by the bond were actively involved in income anyway, except for the interest earned

therefore they do not affect inflation

in fact the value that bond at this point wasn't about to be used for consumption anyway, it was just being held

after the fed purchases the bond, that the former bondholder now has cash that is no longer getting a return, (as now the fed is getting the return)

which will prompt the former bondholder to look for a place to put that money

the idea is that the former bondholder will invest the money, that that money will find its way into funding ventures that cause increased employment, income and production

and it is that investment that will stimulate the economy

like maybe buy other bonds and the issuer of the bond gets that money and can invest in their business, creating jobs and income and production for their employees.

Which then will have the usual multiplier effect if we are at less than full employment

and at any point the fed can sell back the bond reducing the money supply

in the meantime we might have been able to keep the economy functioning at a high level, keep more people from being excluded from the benefits, and not lose all that production that is so essential to increasing our quality of life

djb -> djb... , June 27, 2017 at 02:58 AM
another way to look at inactive money is to say that part of the money supply has no velocity, ie it is not contributing to income.

[Jun 11, 2017] Estimates vary, but some believe 90% of all gold mined in 5000 years is still held by humans as property.

Jun 11, 2017 | economistsview.typepad.com

djb , June 09, 2017 at 02:09 PM

"Bitcoin and the conditions for a takeover of fiat money - longandvariable"

conditions are:

"hell freezing over"

DrDick - , June 09, 2017 at 04:27 PM
Pretty much. Bitcoin really is the quintessential "fiat money" (a redundancy, since all money is fiat currency, even gold and silver).
cm - , June 09, 2017 at 10:07 PM
I would say precious metals are subject to tighter physical constraints (first of all, availability) than most of what have been considered "fiat" currencies.

E.g. emergency "fiat" coin has been produced from cheaper metals, e.g. iron, aluminum, or brass. Forgery-resistant paper currency is not cheap, but probably still cheaper than precious metals.

All that is beside the point - today's currencies are only virtual accounting entries (though with a not so cheap supervision and auditing infrastructure attached to enforce scarcity, or rather limit issuance to approved parties).

mulp - , June 10, 2017 at 03:00 PM
Money is proxy for labor.

Gold and silver prices are determined by labor costs of production.

Cartels act to limit global supply to push prices above labor costs, but even the Cartels have trouble resisting selling into the market when the price far exceeds labor cost of the marginal unit of production.

In today's political economy, the barrier to entry is rule of law which requires paying workers to produce without causing harm to others. The lowest cost new gold production is all criminal, involving theft of gold from land the miners have no property rights, done by causing harm and death to bystanders, with protection of the criminal operations coming from criminals who capture most of the profit from the workers.

Estimates vary, but some believe 90% of all gold mined in 5000 years is still held by humans as property. If a method of extracting gold from sea water at a labor cost of $300 an ounce, the "destruction of wealth" would be many trillions of dollars.

All that's needed is a method of processing sea water that could be built for $300 per ounce of lifetime asset life. A $300 million in labor cost processing ship that kept working for 30 years producing over that 30 years a million ounces of gold would quickly drive the price of gold to $350-400. If it doesn't, a thousand ships would be quickly built that would add a billion ounces to the global supply in 30 years representing 1/6th global supply after 5000 years.

Unless gold suddenly gained new uses, say dresses that every upper middle class women had to have, and that cost more than $300 an ounce to return to industrial gold, such production would force the price of gold to or below labor cost.

However, a dollar coin plated one atom thick in 3 cents of gold will always have a value of a dollar's worth of labor. The number of minutes of labor or the skills required for each second of labor can change, but as long as the dollar buys labor, it will have a dollar of value.

If robots do all the work, then a dollar becomes meaningless. A theoretical economy of robots doing all the work means a car can be priced at a dollar or a gigadollars, but the customers must be given that dollar or that gigadollars, or the robots will produce absolutely nothing. Robots producing a million cars a month which no one has the money to buy means the cars cost zero. To simply produce cars that are never sold means the marginal cost is zero.

cm - , June 11, 2017 at 10:26 AM
Money is a rationing mechanism to control the use and distribution of scarce economic resources. Labor (of various specializations) is a scarce resource, or the scarcest resource commanding the highest price, only if other resources are more plentiful.

There are many cases where labor, even specialized labor, is not the critical bottleneck, and is not the majority part of the price. E.g. in the case of patents where the owner can charge what the market will bear due to intellectual property enforcement. Or any other part of actual or figurative "toll collection" with ownership or control of critical economic means or infrastructure. That's pure rent extraction.

Some things cost a lot *not* because of the labor involved - a lot of labor (not spent on producing the actual good) can be involved because the obtainable price can pay for it.

DrDick - , June 11, 2017 at 11:57 AM
The value of precious metals or gems is also entirely arbitrary. They only have value because someone says they do, as they have little utilitarian value.
cm - , June 09, 2017 at 10:14 PM
The initial allure of bitcoin has been "anonymity", until people figured out that all transactions are publicly recorded with a certain amount of metadata. This can be partially defeated by "mixing services", i.e. systematic laundering. There have also been alleged frauds (complete with arrests) that got a lot of press in the scene, where bitcoin "safekeeping services" (I don't quite want to say "banks") "lost" currency or in any case couldn't return deposits to depositors. No deposit insurance, not much in the way of contract enforcement, etc.

Then there were stories about computer viruses and malware targeted at stealing account credentials or "wallet files".

DrDick - , June 11, 2017 at 12:00 PM
FWIW, I regard bitcoin as a colossal folly intended to appeal to crazed libertarian idiots, goldbug nutters, and criminals and has little utility or real value. Investing in bubble gum cards makes more sense.
DrDick - , June 11, 2017 at 12:01 PM
It is also the ultimate pyramid scheme.

[Apr 25, 2017] The Operation and Demise of the Bretton Woods System: 1958 to 1971

Notable quotes:
"... By Michael Bordo, Professor of Economics, Rutgers University. Originally published at VoxEU ..."
"... See original post for references ..."
"... Greatest scam in history. ..."
"... So, it's not 'out of thin air. It's back by the might of the Pentagon mightier than gold. ..."
"... It is hard to believe in can continue much longer despite of Bordo's view that it will. ..."
Apr 25, 2017 | www.nakedcapitalism.com
Posted on April 25, 2017 by Yves Smith Yves here. The article makes a comment in passing that bears teasing out. The inflation that started in the later 1960s was substantially if not entirely the result of Lyndon Johnson refusing to raise taxes because it would be perceived to be to pay for the unpopular Vietnam War. Richard Nixon followed that approach.

By Michael Bordo, Professor of Economics, Rutgers University. Originally published at VoxEU

Scholars and policymakers interested in the reform of the international financial system have always looked back to the Bretton Woods system as an example of a man-made system that brought both exemplary and stable economic performance to the world in the 1950s and 1960s. Yet Bretton Woods was short-lived, undone by both flaws in its basic structure and the unwillingness of key sovereign members to follow its rules. Many commentators hark back to the lessons of Bretton Woods as an example to possibly restore greater order and stability to the present international monetary system. In a recent paper, I revisit these issues from over a half century ago (Bordo 2017).

The Bretton Woods system was created by the 1944 Articles of Agreement at a global conference organised by the US Treasury at the Mount Washington Hotel in Bretton Woods, New Hampshire, at the height of WWII. It was established to design a new international monetary order for the post war, and to avoid the perceived problems of the interwar period: protectionism, beggar-thy-neighbour devaluations, hot money flows, and unstable exchange rates. It also sought to provide a framework of monetary and financial stability to foster global economic growth and the growth of international trade.

The system was a compromise between the fixed exchange rates of the gold standard, seen as conducive to rebuilding the network of global trade and finance, and the greater flexibility to which countries had resorted in the 1930s to restore and maintain domestic economic and financial stability. The Articles represented a compromise between the American plan of Harry Dexter White and the British plan of John Maynard Keynes. The compromise created an adjustable peg system based on the US dollar convertible into gold at $35 per ounce along with capital controls. The compromise gave members both exchange rate stability and the independence for their monetary authorities to maintain full employment. The IMF, based on the principle of a credit union, whereby members could withdraw more than their original gold quotas, was established to provide relief for temporary current account shortfalls.

It took close to 15 years to get the Bretton Woods system fully operating. As it evolved into a gold dollar standard, the three big problems of the interwar gold exchange standard re-emerged: adjustment, confidence, and liquidity problems.

The adjustment problem in Bretton Woods reflected downward rigidity in wages and prices which prevented the normal price adjustment of the gold standard price specie flow mechanism to operate. Consequently, payment deficits would be associated with rising unemployment and recessions. This was the problem faced by the UK, which alternated between expansionary monetary and fiscal policy, and then in the face of a currency crisis, austerity – a policy referred to as 'stop-go'. For countries in surplus, inflationary pressure would ensure, which they would try to block by sterilisation and capital controls.

A second aspect of the adjustment problem was asymmetric adjustment between the US and the rest of the world. In the pegged exchange rate system, the US served as central reserve country and did not have to adjust to its balance of payments deficit. It was the n-1th currency in the system of n currencies (Mundell 1969). This asymmetry of adjustment was resented by the Europeans.

The US monetary authorities began to worry about the balance of payments deficit because of its effect on confidence . As official dollar liabilities held abroad mounted with successive deficits, the likelihood increased that these dollars would be converted into gold and that the US monetary gold stock would eventually reach a point low enough to trigger a run. Indeed by 1959, the US monetary gold stock equalled total external dollar liabilities, and the rest of the world's monetary gold stock exceeded that of the US. By 1964, official dollar liabilities held by foreign monetary authorities exceeded that of the US monetary gold stock (Figure 1).

Figure 1. US gold stock and external liabilities, 1951-1975

Source : Banking and Monetary Statistics 1941‐1970, Washington DC Board of Governors of the Federal Reserve System, September 1976, Table 14.1, 15.1.

A second source of concern was the dollar's role in providing liquidity to the rest of the world. Elimination of the US balance of payments deficits (as the French and Germans were urging) could create a global liquidity shortage. There was much concern through the 1960s as to how to provide this liquidity.

Robert Triffin (1960) captured the problems in his famous dilemma. Because the Bretton Woods parities, which were declared in the 1940s, had undervalued the price of gold, gold production would be insufficient to provide the resources to finance the growth of global trade. The shortfall would be met by capital outflows from the US, manifest in its balance of payments deficit. Triffin posited that as outstanding US dollar liabilities mounted, they would increase the likelihood of a classic bank run when the rest of the world's monetary authorities would convert their dollar holdings into gold (Garber 1993). According to Triffin when the tipping point occurred, the US monetary authorities would tighten monetary policy and this would lead to global deflationary pressure. Triffin's solution was to create a form of global liquidity like Keynes' (1943) bancor to act as a substitute for US dollars in international reserves.

Policies to Shore Up the System

The problems of the Bretton Woods system were dealt with by the IMF, the G10 plus Switzerland, and by US monetary authorities. The remedies that followed often worked in the short run but not in the long run. The main threat to the system as a whole was the Triffin problem, which was exacerbated after 1965 by expansionary US monetary and fiscal policy which led to rising inflation.

After a spike in the London price of gold to $40.50 in October 1960 – based on fears that John F Kennedy, if elected, would pursue inflationary policies – led the Treasury to develop policies to discourage Europeans from conversing dollars into gold. These included:

The US Treasury, aided by the Federal Reserve, also engaged in sterilised exchange market intervention.

The main instrument used by the Fed to protect the gold stock was the swap network. It was designed to protect the US gold stock by temporarily providing an alternative to foreign central bank conversion of their dollar holdings into gold. In a typical swap transaction, the Federal Reserve and a foreign central bank would undertake simultaneous and offsetting spot and forward exchange transactions, typically at the same exchange rate and equal interest rate. The Federal Reserve swap line increased from $900 million to $11.2 billion between March 1962 and the closing of the gold window in August 1971 (see Figure 2 and Bordo et al. 2015)

Figure 2. Federal Reserve swap lines, 1962 –1973

Source : Federal Reserve System.

The swaps and ancillary Treasury policies protected the US gold reserves until the mid-1960s, and were viewed at the time as a successful policy.

The Breakdown of Bretton Woods, 1968 to 1971

A key force that led to the breakdown of Bretton Woods was the rise in inflation in the US that began in 1965. Until that year, the Federal Reserve Chairman, William McChesney Martin, had maintained low inflation. The Fed also attached high importance to the balance of payments deficit and the US monetary gold stock in its deliberations (Bordo and Eichengreen 2013). Beginning in 1965 the Martin Fed shifted to an inflationary policy which continued until the early 1980s, and in the 1970s became known as the Great Inflation (see figure 3).

Figure 3 . Inflation rates

Source : US Bureau of Labor Statistics, IMF (various issues).

The shift in policy mirrored the accommodation of fiscal deficits reflecting the increasing expense of the Vietnam War and Lyndon Johnson's Great Society.

The Federal Reserve shifted its stance in the mid-1960s away from monetary orthodoxy in response to the growing influence of Keynesian economics in the Kennedy and Johnson administrations, with its emphasis on the primary objective of full employment and the belief that the Fed could manage the Phillips Curve trade-off between inflation and unemployment (Meltzer 2010).

Increasing US monetary growth led to rising inflation, which spread to the rest of the world through growing US balance of payments deficits. This led to growing balance of payments surpluses in Germany and other countries. The German monetary authorities (and other surplus countries) attempted to sterilise the inflows but were eventually unsuccessful, leading to growing inflationary pressure (Darby et al. 1983).

After the devaluation of sterling in November 1967, pressure mounted against the dollar via the London gold market. In the face of this pressure, the Gold Pool was disbanded on 17 March 1968 and a two-tier arrangement put in its place. In the following three years, the US put considerable pressure on other monetary authorities to refrain from converting their dollars into gold.

The decision to suspend gold convertibility by President Richard Nixon on 15 August 1971 was triggered by French and British intentions to convert dollars into gold in early August. The US decision to suspend gold convertibility ended a key aspect of the Bretton Woods system. The remaining part of the System, the adjustable peg disappeared by March 1973.

A key reason for Bretton Woods' collapse was the inflationary monetary policy that was inappropriate for the key currency country of the system. The Bretton Woods system was based on rules, the most important of which was to follow monetary and fiscal policies consistent with the official peg. The US violated this rule after 1965 (Bordo 1993).

Conclusion

The collapse of the Bretton Woods system between 1971 and 1973 led to the general adoption by advanced countries of a managed floating exchange rate system, which is still with us. Yet this outcome (at least at the time) was not inevitable. As was argued by Despres et al. (1966) in contradistinction to Triffin, the ongoing US balance of payments deficit was not really a problem. The rest of the world voluntarily held dollar balances because of their valuable service flow – the deficit was demand-determined. In their view, the Bretton Woods system could have continued indefinitely. This of course was not the case, but although the par value system ended in 1973 the dollar standard without gold is still with us, as McKinnon (1969, 1988, 2014) has long argued.

The dollar standard was resented by the French in the 1960s and referred to as conferring "the exorbitant privilege" on the US, and the same argument was made in 2010 by the Governor of the Central Bank of China. However, the likelihood that the dollar will be replaced as the dominant international currency in the foreseeable future remains remote. The dollar standard and the legacy of the Bretton Woods system will be with us for a long time.

See original post for references

0 0 5 0 0 This entry was posted in Currencies , Economic fundamentals , Globalization , Guest Post , Macroeconomic policy , The dismal science on April 25, 2017 by Yves Smith . Subscribe to Post Comments 59 comments Jim Haygood , April 25, 2017 at 11:00 am

'Because the Bretton Woods parities, which were declared in the 1940s, had undervalued the price of gold, gold production would be insufficient to provide the resources to finance the growth of global trade.'

Twenty years on from Britain's "lost decade" of the 1920s - caused by repegging sterling to gold at the pre-World War I parity - the same mistake was repeated at Bretton Woods. (The US had made the identical error in 1871, which required 25 years of relentless deflation to sweat out Civil War greenback inflation.)

Even as the Bretton Woods conference was underway in 1944, it went unnoticed that the US Federal Reserve had embarked on a vast buying spree of US Treasuries. This was done to peg their yield at 2.5% or below, in order to finance WW II at negative real yields. By 1945, US Treasuries (shown in blue and orange on this chart) loomed larger in the Fed's balance sheet than gold (shown in chartreuse):

http://greshams-law.com/wp-content/uploads/2012/02/Screen-shot-2012-02-12-at-21.23.00.png

Obviously a fixed gold price is utterly incompatible with a central bank expanding its balance sheet with government debt, reducing its gold holdings to the tiny residual that they constitute today.

Bretton Woods might have worked by limiting central banks' ability to monetize gov't securities. Or it might have worked with the gold price allowed to float with expanding central bank assets, according to a formula.

What was lost with Bretton Woods was fixed exchange rates, which are conducive to trade. Armies of traders seeking to extract rents from fluctuations between fiat currencies are a pure deadweight loss to the global economy.

In North America, sharp depreciations of the Mexican and Canadian currencies against the USD are fanning US protectionism, in forms ranging from a proposed border wall to countervailing duties on Canadian lumber and dairy products. What a mess.

Irredeemable fiat currencies are a tribulation visited on humanity. When the central bank blown Bubble III explodes in our fool faces, this insight will be more widely appreciated.

jsn , April 25, 2017 at 1:35 pm

Fiat currency is a tribulation visited on capitalist trade advocates and their financial backers.

International trade, which is hobbled by fiat currencies as you say, was a rounding error in most peoples lives until the Thatcher/Reagan neoliberal innovations.

Since then that rounding error has rounded away most of the distributive properties of the economic systems so distorted to facilitate capital profits through long distance trade that they are impoverishing enough people that Brits vote Brexit, Yanks vote Trump and French vote Le Pen.

Robert NYC , April 25, 2017 at 3:19 pm

Bretton Woods would have worked a lot better if Keynes had won the argument in favor of "bancor", but he was arguing from a position of weakness and lost out.

And yes, when this blows, as it will, it will all become more widely appreciated.

Gman , April 25, 2017 at 5:24 pm

+1.

gepay , April 25, 2017 at 8:30 pm

missing from the article is the decision to raise the price of oil in order to put most of the 3rd world into debt slavery. This exasperated the inflation mentioned, caused by US deficits. Because the US was still a manufacturing leader and the Unions were strong – we had the wage price stagflation of the 70's,. The elites solution – Nixon went to China – not to open up a market of a billion people but to make use of a disciplined labor force that would work for cheap – breaking the power of the unions with globalisation aided by computers. The Republicans in the US and Thatcher in England broke the unions in the 80s.Clinton went along in the 90s. Was that plan a factor in the decision to leave the gold standard?

Susan the other , April 25, 2017 at 11:09 am

This was most interesting for its lack of regret for losing a dollar pegged to $35 oz. gold. It is almost a rationale for letting inflation and deficit spending occur because in the end the system using a reserve currency works as good as anything. I do think the expense of the Vietnam war and the obvious policy that it was necessary to allow inflation (from the 70s onward) was incomplete, looking at everything today, because it was based on an assumption that we humans could just aggressively keep growing our way into the future like we had always done. Already in 1970 there were environmental concerns, well-reasoned ones, and global warming was being anticipated. If it had been possible to use a hard gold standard we might not be in this ecological disaster today, but there would have been some serious poverty, etc. The obvious policy today is to put our money into the environment and fix it and by doing that put people to work for a good and urgent cause. As opposed to bombing North Korea; building a Wall to nowhere; giving money to corporations which do not contribute to repairing the planet; and impoverishing people unnecessarily, etc. Money, in the end, is only as valuable as the things it accomplishes.

Robert NYC , April 25, 2017 at 3:29 pm

Wrong on your poverty concept. It is the inflation associated with a reckless fiat monetary system that causes much of the poverty. Prior the fiat era there was minimal inflation. As Keynes explained in his prophetic criticism of the Treaty of Versailles, The Economic Consequences of the Peace, when he called attention to Lenin, of all people:

"By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls . . . become 'profiteers', who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished not less than the proletariat. As the inflation proceeds . . . all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless.

Lenin was certainly right. There is no subtler, nor surer means of overturning the existing basis of society that to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

jsn , April 25, 2017 at 5:25 pm

The core problem with hard currency is the power asymmetry of the fixed interest contract in whatever form.

Because costs are constant and growing under such contracts, income requirements become "sticky": in a market reverse, wage earners, renters, mortgage holders etc are obligated by these contracts and cannot accept a cut in their wage unless they have adequate financial reserves. Recessions soak these reserves from debtors to creditors despite the loose underwriting of creditors in the speculative and ponzi phases of the Minsky cycle being the root cause of the business cycle, not profligacy or irresponsibility by wage earners and small business people. In a depression, this liquidationist dynamic starts working its way up the the industrial supply chain, dismantling the actual means of production.

The main potential public benefit of fiat currency is that in such conditions it costs the state nothing to preserve the wealth of those not implicated in causing the collapse and to preserve those means of production. Unfortunately, what we saw in 2008 was Bush/Obama using the innocent victims of the business cycle to "foam the runway" for the institutions that caused it.

Poverty is a simple result of being cut off from possible income sources. To the extent that inflation is managed with what Keynes called "a reserve army of the unemployed", high levels of poverty are assured. In the high wage, high cost era of the New Deal, the intent was take what burden of financial risk could be taken off of workers and small producers and to provide good paying opportunities for one cycle's economic losers to get back on their feet in the next cycle. But this only works with full employment where labor has the power to bid for a share of the overall returns on investments.

OpenThePodBayDoorsHAL , April 25, 2017 at 6:53 pm

I found this fascinating and quite persuasive.
But unless you can posit the existence of a state that will reliably act to "preserve the wealth of those not implicated in causing the collapse and to preserve those means of production" it is just a useless academic exercise. I do not see any such state anywhere in view, with the possible exception of the Chinese, who seem to understand "preserving the means of production" as a state priority. For the West however that idea is a real howler.

Moneta , April 25, 2017 at 7:30 pm

No inflation can also lead to a form of confiscation where you are not letting new entrants (the young) into the game.

No inflation could reflect a form of protectionism.

MyLessThanPrimeBeef , April 25, 2017 at 3:30 pm

If it had been possible to use a hard gold standard we might not be in this ecological disaster today, but there would have been some serious poverty, etc.

Some serious poverty only if because the elites would have been even more neoliberal.

The last gold-standard-free 50 years of innovation and growth have made extinct

1. Shoes that last more than a few months
2. Clothes that you can pass on to future generations
3. Likewise, furniture
4. Milk or Coke in glass bottles
etc.

RBHoughton , April 25, 2017 at 7:35 pm

Isn't that because we have evicted competition from our global commercial model and replaced it with planned production so every factory knows the size of its likely market?

Enquiring Mind , April 25, 2017 at 11:18 am

At what point would China, for example, be able to assert more of a reserve currency, or at least alternative, role based on its economic and trade power and build-up of hard and financial assets? Or is their near-term internal surplus recycling through uneconomic lending enough to keep them off-balance for quite a while on the world financial stage? Many in the West are watching the development of the One Belt/One Road infrastructure and shifting country linkages and alliances with grave concern.

jsn , April 25, 2017 at 1:09 pm

The key to reserve status is large external holdings of your monetary instruments: for foreigners to transact in your currency they must have it. China, thus far, fails profoundly on this count, no one has its currency.

The inverse of this is that the best way for the US to end the dollars reserve status is to eliminate the "National Debt", which is in fact nothing other than the inventory if dollar instruments the rest of the world holds in order to be able to spend dollars into our system: eliminate that inventory and the dollar will no longer be a reserve currency.

Oregoncharles , April 25, 2017 at 1:28 pm

This raises the large question of whether "reserve status" is actually beneficial. Apparently it consists largely of being enormously in debt – and in fact, it's been a way for Japanese and Chinese to buy up large chunks of our "means of production." The prosperity of my original home town, Columbus, IN, rests on Japanese "investment." It does mean some good Japanese restaurants in town.

jsn , April 25, 2017 at 3:25 pm

To me the question is, who benefits from it? It has been of great benefit to a very particular set of people here in the US and quite destructive since the 70s to most everyone else.

It is a power relationship that has been used for imperial aims rather than for the good of citizens. It needn't be that way, but as US power has become increasingly unaccountable its abuse of this particular tool has grown.

Robert NYC , April 25, 2017 at 3:54 pm

@jsn, you get it!

Yves Smith Post author , April 25, 2017 at 9:39 pm

No, no, no, no, this is 100% wrong.

First, the US could just as easily deficit spend. We are not "in debt" because the US can always create more dollars to retire Treasury bonds.

The requirement for being a reserve currency is running trade deficits. That does require that furriners take and hold your paper. They prefer bonds or other investments to cash to get some yield.

Running ongoing trade deficits also means that you are using your domestic demand to support jobs overseas. That is the problematic feature, not all of this other noise.

Robert NYC , April 25, 2017 at 3:45 pm

The concept of a reserve currency came about from resolution 9 of the Genoa Monetary Conference of 1922. The idea was that any currency that was convertible to gold was de facto equivalent to gold and therefore an acceptable central bank reserve asset. In other words there is really no such thing as an international reserve currency without gold in the system according to the very reasoning that established the idea. The U.S. pulled off the greatest bait and switch in history when it "suspended" the gold window in 1971. The whole system because an enormous debt based Ponzi scheme after that and we are now dealing with the consequences.

And yes the key to reserve status: is large external holdings of your monetary instruments for foreigners to transact in". But what incentive do they have to hold such a currency and transact in it? Remember they don't need it since they generally run trade surpluses. The answer was, because that currency was convertible to gold. What about now when it is not tied to gold? Why hold the currency of profligate debtor nation? Answer provided in post below.

And anyone who thinks that running large trade and budget deficits is the secret to reserve currency status is a moron. Argentina or Paraguay could just as easily produce the necessary surplus liquidity under that logic.

craazyboy , April 25, 2017 at 4:07 pm

" But what incentive do they have to hold such a currency and transact in it? Remember they don't need it since they generally run trade surpluses. "

Restart back at the very beginning, forget everything you know, and try again.

"They" got foreign reserve currency by selling to the US and getting paid in dollars. Their banks then traded the dollars to the PBoC central bank for freshly printed renimbi.

Robert NYC , April 25, 2017 at 4:30 pm

yes, but why would the central bank endlessly collect another country's debt?

And you inadvertently point out one of the key frauds in the system. The dollar supports a double pyramid of credit, one domestic and the other foreign. There is also a third pyramid of credit, the euro dollar market, which is built on top of the U.S. domestic pyramid of credit, but lets ignore that for now.

So "they" give us real stuff made of raw material and labor inputs and we give them wampum!!! Greatest scam in history.

Mark P. , April 25, 2017 at 5:33 pm

Greatest scam in history.

It absolutely is. It's as much an advance on the British Empire as that was on the Roman system.

craazyboy , April 25, 2017 at 5:41 pm

"The dollar supports a double pyramid of credit, one domestic and the other foreign. "

Except the PBoC prints the Many Yuan to buy dollars from the Chinese banking system. The value of the Many Yuan is backed by sales of exports, in that case. A tiny little subset where MMT (The imaginary version) is actually in force. Then the PBoC buys our debt with these foreign reserves, which we wisely spend on our country and citizens.

Next, the Chinese banking system, thru the power of The Money Multiplier, uses that base money to make loans and expand credit to Chinese.

Robert NYC , April 25, 2017 at 8:14 pm

" The value of the Many Yuan is backed by sales of exports, in that case."

WTF? The value the "Many Yuan" is backed by the sale of exports which yields wampum, uh I mean dollars, and they purchase the dollars with the many yuan they created. The PBoC expands its balance sheet to buy those dollars with yuan created from nothing, hence the double pyramid of credit. The dollars get lent back to us in the form of U.S. government securities because we issue the word's "boomerang" currency.

And yes you can run a system like this; for how long? That is the big question.

Yves Smith Post author , April 25, 2017 at 9:45 pm

No, you have this wrong.

They want the jobs!

And you have misunderstood what those reserves are for. The Fed also can't spend all of those US assets it holds on its balance sheet either, now can it?

The use of foreign currency reserves is to defend the currency and keep the IMF away. Having a currency depreciate rapidly leads to a big inflation spike (unless you are close to being an autarky) due to the prices of foreign goods, in particular commodities, going up in your currency.

China is not self sufficient in a whole bunch of things, including in particular energy.

It had a spell last year when it was running through its FX reserves at such a rate that it would have breached the IMF trouble level for an economy of its size if it had persisted for 4-6 months more.

Robert NYC , April 25, 2017 at 4:56 pm

You sound like you must be an economist.

A chemist, a physicist and economist are ship wrecked on a deserted island with only some canned goods for food. They sit down to figure out how they are going to open the cans. To which the economist says: "assume we have a can opener"

craazyboy , April 25, 2017 at 5:47 pm

Three MMT Economists are stranded on a desert island.

They say, "WTF's a can opener? That sounds like work!" and live 3 months and are then rescued by Skipper, Gillian, Mary Ann and the Perfesser too, on an Easter Break Tour. Ginger and Mr. Howe are downstairs busy downstairs knocking up.

They are living happily ever after in Kansas City, Mo.

a different chris , April 25, 2017 at 11:41 am

>The dollar standard will be with us for a long time.

Why?

jsn , April 25, 2017 at 1:01 pm

That struck me as "famous last words" material.

Seems to me the dollar system will work until it doesn't. And those who run it have been doing all within their power for about 15 years to encourage anyone who can to come up with an alternative.

None look viable, and they won't until suddenly one is.

Yves Smith Post author , April 25, 2017 at 9:49 pm

There isn't a viable alternative.

The euro isn't one due to the mess its banking system is in. Japan doesn't want the job and in any event is a military protectorate of the US.

China is a minimum of 20 years away. Even though it would like the status of being the reserve currency, it most decidedly does not want the attendant obligations, which are running ongoing trade deficits, which is tantamount to exporting jobs. Maintaining high levels of employment and wage growth are the paramount goals for China's leaders. There are underreported riots pretty much all the time in China due to dissatisfaction over labor conditions now. The officialdom is not going to commit political suicide. Domestic needs always trump foreign goals.

lyman alpha blob , April 25, 2017 at 11:43 am

Just getting around to reading Piketty's doorstopper and was struck by his argument that prior to WWI there had been very little inflation worldwide for centuries. It was the need to pay off all the war debt that shook things up.

Graeber's book on debt also makes the argument that money as physical circulating metal currency came about because of the need to pay for wars.

Something similar seems to have been going on with the Bretton Woods agreement.

I know it's crazy but I'm just going to throw it out there – maybe if we'd like a more stable economy we could try starting fewer very destabilizing, extremely expensive wars???

wandering mind , April 25, 2017 at 3:16 pm

That is exactly my thought. There is a disturbing cycle of war, monetary expansion to pay for the war, post-war deflation leading to political instability, leading to a repeat of the cycle, at least in Europe and the U.S.

One can see this even in the period between the creation of the Bank of England through the end of the Napoleonic wars.

It is evident as well in the United States pre- and post-Civil war.

Deficit hawks never seem to have a problem with war-time deficit spending, only general welfare deficit spending.

We could have a system where the fiscal power of the state is fully harnessed for the general welfare, but that would threaten the current system which allows a small minority to overwhelmingly reap the benefits of the money creation power of the state and private banks.

This renders the issue a political one more than a purely economic one. If history is any guide, we will continue to have the kind of political uncertainty we've experienced until there has been enough war spending to start the cycle over again. :(

RBHoughton , April 25, 2017 at 7:42 pm

Wander no more Mind, you have struck on the bedrock of reality

Henry , April 25, 2017 at 12:21 pm

" The inflation that started in the later 1960s was substantially if not entirely the result of Lyndon Johnson refusing to raise taxes "

I'm almost afraid to ask, but how does this make sense? Any increase in taxes will be passed on to the consumer to increase prices even more. If you doubt this, watch what Trump's import taxes do to prices.

Yves Smith Post author , April 25, 2017 at 9:54 pm

No, you have been propagandized by the right wing anti tax people.

Taxes drains demand from the economy. Lower demand means more slack, more merchants having to compete with each other, some headcount cuts, etc.

By deficit spending in an economy that was already at full employment, Johnson basically guaranteed inflation. Both his own former economist, Walter Heller, and Milton Friedman warned against it. But because Heller was a Dem and an outlier (most Dems weren't gonna challenge their own party's policies), it was Friedman's warnings that were publicized.

Kalen , April 25, 2017 at 1:16 pm

Another subject that is relevant to the current post 2008 collapse and FED shenanigans to save the day. i.e. save their cronies. And what it is completely missing in this piece written by the insiders is exactly that Bretton Woods; Cui Bono:namely US ruling elite and new world order after WWII.

Bretton Woods was a monetary session of the overall conference 1944-1945 of new world order namely a formal switch from British empire global dominance system into American global dominance system and trade/monetary policies were just an important but small part of overall new global political and military arrangement.

Global pound was killed, global dollar has been created and blessed by western sphere of influence and defended by supposedly the most powerful US militarily in the world, [as was British navy before] US military of global reach via US navy and air force.

The political symbolism of Bretton Woods conference correlated with invasion of Normandy in June 1944, the last step in defeating Nazism in Europe cannot be understated.

Also the dominance of two figures of White and Keynes in this conference is an exemplification of closing era of British empire as a world [decaying at that time] leader which was accelerated by the role of Japanese and German/Italian aggression in colonial Asia, Africa [also helped by French surrender to Nazis that spurred western support for independent French colony of Algeria] and ME boosted up the anti-colonial movements and political parties, which like in Vietnam even US supported during WWII.

Little known fact is that Nazis championed themselves as anti-colonial force in ME while they attempted to colonize eastern Europe.The many Arabs fell for this propaganda siding with Nazis against British colonialism in Palestine setting themselves against Jews vehemently anti Nazi at that time.

In other words Bretton Woods was a consequence of the fact that British empire was collapsing fast ironically with the help of its allies and that Included Soviets. Also helped that British were broke and all the British Gold was already in the US as a payment for bankrolling British defenses in Europe since 1940 and elsewhere, so were Soviet gold payments for military technology and materiel they received from US and allies.

The political void had to be filled or it would have been filled by Soviets, and hence the Bretton Woods system was not based on unfettered exploitation of slaves of newly expanded US empire what US Oligarchy would have liked and was freely practicing before 1929, but for ideological reason was aimed for economic improvements in order to stem massive anti-capitalist, communist and anti-colonist movements that threatened western hegemony over the world and hence the dreaded anti-capitalist words used by in Bretton Woods system like fixed exchange rate or blasphemous capital controls, things the would crucify you if you utter them today during a seminar in any Ivy league economy department.

Bretton Woods was primarily a tool into an ideological war west and Soviets knew they would have to fight, cold or hot.

This [economic dominance] war ended in mid nineteen sixties when seeds of collapse of Soviet Union and betrayal of leftist ideals and socialist/communists movements all over the world were sawed and hence Bretton Woods was no longer needed and brutality of unfettered capitalist could begin to return starting with Kennedy tax cut freeing capital in private hands and then FED going full fiat in later 1960-ties, capital flow deregulation, free floating currencies, all that for benefit of oligarchic class and of colossal detriment to American workers, devastating result of which we are experiencing now.

jsn , April 25, 2017 at 1:48 pm

One of the great ironies of Bretton Woods is that Harry Dexter White, the US rep at the talks was in fact a Soviet agent. I wonder if he understood monetary economics enough to hope that the Bretton Woods gold standard system, as opposed to Keynes bancor proposal, would self immolate with a run on US gold stocks and take the West down with it.

OpenThePodBayDoorsHAL , April 25, 2017 at 6:15 pm

Let's think of "root causes", both Keynes and White were big fans of Soviet-style command and control top-down planned economies ("I have seen the future and it works!"). So that's what they divined and devised for money: a top-down price-fixing regime.

So while people would laugh themselves silly if you told them we were going to price things the way the Soviets did ("we'll raise X number of cows because we'll need Y quantity of shoe leather"), we somehow accept central planning for the price of the most important item of all: money itself. The supreme geniuses at the Fed et al, with their supreme formulae, can divine at any moment precisely what the price of money should be. This, of course, is folly.

And people should understand that the gold standard (not the gold-exchange standard it is often confused with) was not designed, was not somehow imposed, and was not agreed upon by some collective body. It simply arose organically because time and again through painful experience throughout history it was shown that any system where people can simply vote themselves more money ends in tears. Not usually, but always. You'd think that a 100% historical failure rate would clue people in to rethink the head-hammer-hitting approach.

And as Dr. Haygood points out above, "everything floating against everything else" is nothing but a colossal waste of time and money. You wouldn't attempt to build or make something without an agreed and immutable unit of measure.

jsn , April 25, 2017 at 6:46 pm

Completely untrue of Keynes. He ran the UK Treasury twice very pointedly in the interests of industrial capitalists. He was however very opposed to financial rents, a real classicist in that regard.

jsn , April 25, 2017 at 7:07 pm

Keynes ran the UK treasury twice more or less along classical lines: in favor of industrial capitalism and against financial rents. Not top down, not Soviet. Its not clear where you get your facts, fiat systems have lasted hundreds of years many times. They tend to arise in empires with secure borders. They depend on the productive relations of their societies for the value of their money rather than a commodity hedge.

Warfare favors the commodity hedge because the productive relations in a society are frequently destroyed by war. Because of the stickyness of wages, hard currency tends to choke economic growth because a fixed money supply has to be spread increasingly thin as more real wealth is created to be denominated with a fixed quantity of specie, requiring wages to drop because there is more stuff to purchase.

Each has benefits and costs, both are tools and while the one favors growth and the other war, neither must be used for either. A representative system will use either as its constituencies direct, an authoritarian one according to the intent of the authority. It isn't tools that make the problems, though some are better for some purposes than others. It is the intent of the powerful that is expressed and from which others suffer.

Robert NYC , April 25, 2017 at 8:18 pm

@jsn " fiat systems have lasted hundreds of years many times."

what? can you please back that statement up. Only major fiat system in history that I have ever seen written about is the one that existed in China several hundred years ago. If there were others you need to give some examples.

Todde , April 25, 2017 at 10:24 pm

Split Tally sticks.

OpenthepodbaydoorsHAL , April 25, 2017 at 9:58 pm

I think you objected to my comments without actually refuting them:
1. We have a top-down price fixing money system;
2. Keynes and White were a big fans of Soviet central planning (see The Battle for Bretton Woods for chapter and verse);
3. And I've never understood the "fixed quantity of specie" argument. Surely it's about price, not physical quantity. You could easily run the world economy on 100 tons of gold if it was priced accordingly.

Vikas Saini , April 25, 2017 at 2:41 pm

Michael Hudson's book Superimperialism, published astonishingly in 1972, nailed it. Details some great history of FDR's economic diplomacy during the late Depression and WW2 period that preceded the Bretton Woods settlement. Worth a read.

Mark P. , April 25, 2017 at 5:14 pm

More than worth a read. Essential.

Robert NYC , April 25, 2017 at 9:46 pm

yes Michael Hudson is great, but that is why he must be marginalized/ignored. Can't maintain control of the official narrative if people like Hudson were to ever be taken seriously..

Robert NYC , April 25, 2017 at 3:16 pm

"However, the likelihood that the dollar will be replaced as the dominant international currency in the foreseeable future remains remote. The dollar standard and the legacy of the Bretton Woods system will be with us for a long time."

That is the BIG question and the answer remains to be seen. I for one don't believe it will continue much longer, but then again nobody knows. Bordo also leaves out a critical part of the narrative, i.e., the U.S. secret deal with Saudi Arabia in 1974 to officially tie the dollar to oil. See link below for details. Without this secret arrangement the dollar would have never survived as the international reserve currency. The Saudis reportedly pushed for greater use of the SDR, but the U.S. made them a deal they couldn't refuse and the Saudi royal family realized that if they didn't go along with U.S. demands the CIA would find some other branch of the family that would.

https://www.bloomberg.com/news/features/2016-05-30/the-untold-story-behind-saudi-arabia-s-41-year-u-s-debt-secret

The system is a mess and it is retarded to allow one country's currency to serve as the main reserve asset for the system. That is the ultimate free lunch and the equivalent to believing in a perpetual motion machine. It is hard to believe in can continue much longer despite of Bordo's view that it will. It has reached a point where it has created massive problems that can not continue.

MyLessThanPrimeBeef , April 25, 2017 at 3:33 pm

So, it's not 'out of thin air.

It's back by the might of the Pentagon mightier than gold.

Robert NYC , April 25, 2017 at 3:49 pm

Exactly! But nobody at the Fed is going to explain this to anyone, anytime soon.

Mark P. , April 25, 2017 at 5:30 pm

MyLessThanPrimeBeef wrote: So, it's not 'out of thin air. It's back by the might of the Pentagon mightier than gold.

And in turn the seignorage on that ability to create as much of the global reserve currency as the U.S. likes pays for the Pentagon.

https://en.wikipedia.org/wiki/Seigniorage

So in a sense when China and Russia are forced to hold dollars for global trade, they're essentially paying for the Pentagon to do what it's doing. You can see why they'd be mad.

steven , April 25, 2017 at 3:47 pm

It is almost a gift from heaven when fixing a single problem offers the chance to fix a whole bunch of them. This IMHO is very possibly one of those gifts. Without this "ultimate free lunch" the globalization scam of allowing this country's and the world's 1% to keep adding zeros to their bank accounts ("to keep score" as Pres. Trump puts it) would not have been possible. Without countries like Saudi Arabia willing to keep accepting more "debt that can't be repaid (and) won't be", the US military industrial complex would not be able to keep increasing its threat to world peace and threatening the survival of humanity. Without the Saudi stranglehold over politics and US Middle Eastern policy the US could stop killing Muslims in its bogus 'war on terror'. It could get busy replacing its fossil fuel energy sources with renewable ones and its oil-powered transportation system with an electrified one (yes, maybe even a few EVs)

@Robert NYC – Thanks for the link.

Mark P. , April 25, 2017 at 5:23 pm

It is hard to believe in can continue much longer despite of Bordo's view that it will.

And yet where is the dollar's replacement?

If you'd told me ten years that the petrodollar as an institution enforcing compliance w. the dollar as global reserve currency could end and yet the dollar would continue with that status, I'd have laughed at you. However, that increasingly looks like it might happen.

Yes, yes, I know - we await the basket of currencies solution pushed by China and Russia, and others sick of the situation. We've been waiting for a while now.

Steven , April 25, 2017 at 7:03 pm

I'm thinking globalization has something to do with the dollar's longevity. Strip a country of the ability to support itself by exporting its jobs and it's people become dependent on a strong military to insure it's money continues to be "accepted" even when it's people no longer have anything to trade for what they really need.

Moneta , April 25, 2017 at 8:19 pm

I think there is indeed a link between the usd as reserve currency and the military budget.

Robert NYC , April 25, 2017 at 9:12 pm

@Moneta, these numbers are roughly correct. The U.S. defense budget is about $600 billion, the trade deficit is about $600 billion and last year we issued $1.4 trillion in incremental debt. Foreigners own about 40% of U.S. debt. 40% of of $1.4 trillion is $560 billion so yes there is a pretty strong correlation. Massive defense budget wouldn't be possible without reserve currency scam.

Robert NYC , April 25, 2017 at 8:21 pm

@Mark P.

yes that is the conundrum. It doesn't make a lot of sense but it goes on and on. Another 50 years? Unlikely.

Adamski , April 25, 2017 at 7:20 pm

I'm completely confused. Anything available in plain English for laypeople?

"The adjustment problem in Bretton Woods reflected downward rigidity in wages and prices which prevented the normal price adjustment of the gold standard price specie flow mechanism to operate"

George Job , April 25, 2017 at 9:05 pm

That fiat currencies have lasted hundreds of years jsn is simply not true. I was thinking forty but here we see 27!
http://georgewashington2.blogspot.com/2011/08/average-life-expectancy-for-fiat.html

And it's the US and Canada being the only countries globally not marking their gold holdings to market. (or audit) Reserve currency indeed!
http://marketupdate.nl/en/analysis-china-marks-gold-reserve-at-market-value/

Tim , April 25, 2017 at 9:52 pm

Canada which was one of the founding members of Bretton Woods pulled out as early as 1949 in order to move to a floating exchange rate and full capital mobility. Bretton Woods was dead before it ever began.

[Apr 14, 2017] If the Federal Reserve can create trillions of dollars with a single keystroke, and the Fed is the governments bank, then why does President Obama claim weve run out of money?

Apr 14, 2017 | economistsview.typepad.com
RGC , April 14, 2017 at 05:48 AM
So ask yourself this question:

If the Federal Reserve can create trillions of dollars with a single keystroke, and the Fed is the government's bank, then why does President Obama claim we've "run out" of money?

Why have Democrats and so-called progressives supported job-killing budget cuts in the name of "shared sacrifice"? Why are we throwing away the equivalent of $9.8 billion in lost output every single day? Why don't we do something about our $2.2 trillion infrastructure deficit, 25 million underemployed and unemployed Americans, 100 million Americans in or very near poverty, and so on?

The answer is simple. Most of us don't understand the monetary system. Instead of deciding how the government should wield its power over the dollar, we live in fear of the ratings agencies, the Chinese, the bond market vigilantes and other imaginary evils. And this holds all of us back. Unused resources abound, human needs go unmet, and the vast majority of Americans believe that 'There Is No Alternative' (TINA). Or, as Warren Mosler says, "Because we fear becoming the next Greece, we're turning ourselves into the next Japan."

There is an alternative. And it begins with an understanding of the monetary system. The cat is already out of the bag. Chairman Bernanke confirms it. Money is no object.

http://neweconomicperspectives.org/2012/03/where-did-the-federal-reserve-get-all-that-money.html

RGC -> RGC... , April 14, 2017 at 05:51 AM
Prominent C20th Economist Explains How the Lie is for Our Own Good

Posted on 2 January 2014

Infamous footage of Paul Samuelson, posted by Mike Norman, explaining why we can't be trusted with the truth.

Just believe the scary bedtime story about the big bad Budget Deficit and stay asleep now. There's a good child.

http://heteconomist.com/prominent-c20th-economist-explains-how-the-lie-is-for-our-own-good/

BenIsNotYoda -> RGC... , April 14, 2017 at 06:59 AM
RGC,
the people here have been brainwashed and can not think for themselves. If it has not been approved by their favorite academic, it is a crank theory. they'd rather believe in fairy tales like NGDP level targeting - the fed will wish it into reality. Rather than pay attention to the MMT that you and I subscribe to.
BenIsNotYoda -> BenIsNotYoda... , April 14, 2017 at 07:04 AM
Moreover it is logical for them to stick to the "the Fed is omnipotent" as it bids up asset prices and maintains the status quo. It vests more power in the institutions that benefit the people you see here.

Blame the right, blame the deregulators, blame the tax cutters, blame the liberatarians, etc. that is the how they maintain the status quo. And Mosler is right on - Bernanke turned us into Japan trying to save us from that fate. And he is sliding down the rabbit hole - "I should have doubled down on my failed strategy"
why? because he was able to bid up the stock market? I bet you everyone of the Fed worshippers here benefit personally from the asset price binges that the stupid Fed has gotten us addicted to.

RGC -> BenIsNotYoda... , April 14, 2017 at 07:40 AM
There has been a major propaganda element in economics for a long time.

People have to dig deep to discover the truth and many don't have the time.

There is a lot of money behind the propaganda on the neoclassical/neoliberal side so it gets a lot more publicity.

As that side sinks the society deeper and deeper into malfunction, hopefully more people will take the time to understand.

JohnH -> RGC... , April 14, 2017 at 09:13 AM
Yep! "There has been a major propaganda element in economics for a long time."

Robert Rubin had an opinion piece at the Council on Foreign Relations, another propaganda rag: "Don't Politicize the Federal Reserve"
http://www.cfr.org/monetary-policy/dont-politicize-federal-reserve/p39037

Per Rubin and his cronies in the Wall Street banking cartel, the Fed is fine as it is...serving the interests of the Wall Street banking cartel. The cartel has a good think going...why disrupt it by taking into account the public good?

Has Rubin ever done anything in the interest of the public?

[Apr 13, 2017] I hate the word manipulation in this context. China isn't doing anything in the dark of the night that we are trying to catch them at.

Apr 13, 2017 | economistsview.typepad.com
anne , April 13, 2017 at 07:44 AM
http://cepr.net/blogs/beat-the-press/china-and-currency-values-fast-growing-countries-run-trade-deficits

April 13, 2017

China and Currency Values: Fast Growing Countries Run Trade Deficits

I don't generally comment on pieces that reference me, but Jordan Weissman has given me such a beautiful teachable moment that I can't resist. Weissman wrote * about Donald Trump's reversal on his campaign pledge to declare China a currency manipulator. Weissman assures us that Trump was completely wrong in his campaign rhetoric and that China does not in fact try to depress the value of its currency.

"It's pretty hard to argue with that. Far from devaluing its currency, China has actually spent more than $1 trillion of its vaunted foreign reserves over the past couple of years trying to prop up the value of the yuan as investors have funneled money overseas. There are some on the left, like economist Dean Baker, who will argue that Beijing is still effectively suppressing the redback's value by refusing to unwind its dollar reserves more quickly. But if China were really keeping its currency severely underpriced, you'd expect it to still have a big current account surplus, reminiscent of 10 years ago, which it doesn't anymore."

Okay, to start with, I hate the word "manipulation" in this context. China isn't doing anything in the dark of the night that we are trying to catch them at. The country pretty explicitly manages the value of its currency against the dollar, that is why it holds more than $3 trillion in reserves. So let's just use the word "manage," in reference to its currency. It is more neutral and more accurate.

It also allows us to get away from the idea that China is somehow a villain and that we here in the good old US of A are the victims. There are plenty of large U.S. corporations that hugely benefit from having an under-valued Chinese currency. For example Walmart has developed a low cost supply chain that depends largely on goods manufactured in China. It is not anxious for the price of the items it imports rise by 15-30 percent because of a rise in the value of the yuan against the dollar.

The same applies to big manufacturers like GE that have moved much of their production to China and other developing countries. These companies do not "lose" because China is running a large trade surplus with the United States, they were in fact big winners.

Okay, but getting back to the issue at hand, I'm going to throw the textbook at Weissman. It is not true that we should expect China "to still have big current account surplus" if it were deliberately keeping its currency below market levels.

China is a developing country with an annual growth rate of close to 7.0 percent. The U.S. is a rich country with growth averaging less than 2.0 percent in last five years. Europe is growing at just a 1.0 percent rate, and Japan even more slowly. Contrary to what Weissman tells us, we should expect that capital would flow from slow growing rich countries to fast growing developing countries. This is because capital will generally get a better return in an economy growing at a 7.0 percent rate than the 1-2 percent rate in the rich countries.

If capital flows from rich countries to poor countries, this means they are running current account surpluses. The capital flows are financing imports in developing countries. These imports allow developing countries to sustain the living standards of their populations even as they build up their infrastructure and capital stock. In other words, if China was not depressing the value of its currency we should it expect it to be running a large trade deficit.

This is actually the way the world worked way back in the 1990s, a period apparently beyond the memory of most economics reporters. The countries of East Asia enjoyed extremely rapid growth, ** while running large trade deficits. This all changed following the East Asian financial crisis and the disastrous bailout arranged by Secretary of Treasury Robert Rubin and friends. *** Developing countries became huge exporters of capital as they held down the value of their currencies in order to run large trade surpluses and build up massive amounts of reserves.

But Weissman is right that China is no longer buying up reserves, but the issue is its huge stock of reserves. As I explained in a blogpost **** a couple of days ago:

"Porter is right that China is no longer buying reserves, but it still holds over $3 trillion in reserves. This figure goes to well over $4 trillion if we include its sovereign wealth fund. Is there a planet where we don't think this affects the value of the dollar relative to the yuan?

"To help people's thought process, the Federal Reserve Board holds over $3 trillion in assets as a result of its quantitative easing program. I don't know an economist anywhere who doesn't think the Fed's holding of assets is still keeping interest rates down, as compared to a scenario in which it had a more typical $500 billion to $1 trillion in assets.

"Currencies work the same way. If China offloaded $3 trillion in reserves and sovereign wealth holdings, it would increase the supply of dollars in the world. And, as Karl Marx says, when the supply of something increases, its price falls. In other words, if China had a more normal amount of reserve holdings, the value of the dollar would fall, increasing the competitiveness of U.S. goods and services, thereby reducing the trade deficit."

So, there really are no mysteries here. China is holding down the value of its currency, which is making the U.S. trade deficit worse. It is often claimed that they want their currency to rise. That may well be true, which suggests an obvious opportunity for cooperation. If the U.S. and China announce a joint commitment to raise the value of the yuan over the next 2-3 years then we can be fairly certain of accomplishing this goal.

This should be a very simple win-win for both countries. Walmart and GE might be unhappy, but almost everyone else would be big winners, especially if we told them not to worry about Pfizer's drug patent and Microsoft's copyright on Windows.

* http://www.slate.com/blogs/moneybox/2017/04/12/trump_changes_his_mind_decides_china_isn_t_a_currency_manipulator_after.html

** http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/weorept.aspx?pr.x=45&pr.y=7&sy=1990&ey=2000&scsm=1&ssd=1&sort=country&ds=.&br=1&c=522%2C924%2C536%2C578%2C548%2C582&s=NGDP_RPCH%2CBCA_NGDPD&grp=0&a=

*** http://img.timeinc.net/time/magazine/archive/covers/1999/1101990215_400.jpg

**** http://cepr.net/blogs/beat-the-press/trump-china-and-trade

-- Dean Baker

[Apr 13, 2017] Currency manipulation vs currency management

Apr 13, 2017 | economistsview.typepad.com
anne , April 12, 2017 at 08:23 AM
http://cepr.net/blogs/beat-the-press/trump-china-and-trade

April 11, 2017

Trump, China, and Trade

It is unfortunate that Donald Trump seems closer to the mark on China and trade than many economists and people who write on economic issues for major news outlets. Today, Eduardo Porter gets things partly right in his column * telling readers "Trump isn't wrong on China currency manipulation just late." The thrust of the piece is that China did in fact deliberately prop up the dollar against its currency, thereby causing the U.S. trade deficit to explode. However, he argues this is all history now and that China's currency is properly valued.

Let's start with the first part of the story. It's hardly a secret that China bought trillions of dollars of foreign exchange in the last decade. The predicted and actual effect of this action was to raise the value of the dollar against the yuan. The result is that the price of U.S. exports were inflated for people living in China and the price of imports from China were held down.

Porter then asks why the Bush administration didn't do anything when this trade deficit was exploding in the years 2002–2007. We get the answer from Eswar Prasad, a former I.M.F. official who headed their oversight of China:

"'There were other dimensions of China's economic policies that were seen as more important to U.S. economic and business interests,' Eswar Prasad, who headed the China desk at the International Monetary Fund and is now a professor at Cornell, told me. These included 'greater market access, better intellectual property rights protection, easier access to investment opportunities, etc.'"

Okay, step back and absorb this one. Mr. Prasad is saying that millions of manufacturing workers in the Midwest lost their jobs and saw their communities decimated because the Bush administration wanted to press China to enforce Pfizer's patents on drugs, Microsoft's copyrights on Windows, and to secure better access to China's financial markets for Goldman Sachs.

This is not a new story, in fact I say it all the time. But it's nice to have the story confirmed by the person who occupied the International Monetary Fund's China desk at the time.

Porter then jumps in and gets his story completely 100 percent wrong:

"At the end of the day, economists argued at the time, Chinese exchange rate policies didn't cost the United States much. After all, in 2007 the United States was operating at full employment. The trade deficit was because of Americans' dismal savings rate and supercharged consumption, not a cheap renminbi. After all, if Americans wanted to consume more than they created, they had to get it somewhere."

Sorry, this was the time when even very calm sensible people like Federal Reserve Board Chair Ben Bernanke were talking about a "savings glut." The U.S. and the world had too much savings, which lead to a serious problem of unemployment. Oh, we did eventually find a way to deal with excess savings.

Anyone remember the housing bubble? The demand generated by the bubble eventually pushed the labor market close to full employment. (The employment rate of prime age workers was still down by 2.0 percentage points in 2007 compared to 2000 - and the drop was for both men and women, so skip the problem with men story.)

Yeah, that bubble didn't end too well. So much for Porter's no big deal story.

But what about the present, are we all good now?

Porter is right that China is no longer buying reserves, but it still holds over $3 trillion in reserves. This figure goes to well over $4 trillion if we include its sovereign wealth fund. Is there a planet where we don't think this affects the value of the dollar relative to the yuan?

To help people's thought process, the Federal Reserve Board holds over $3 trillion in assets as a result of its quantitative easing program. I don't know an economist anywhere who doesn't think the Fed's holding of assets is still keeping interest rates down, as compared to a scenario in which it had a more typical $500 billion to $1 trillion in assets.

Currencies work the same way. If China offloaded $3 trillion in reserves and sovereign wealth holdings, it would increase the supply of dollars in the world. And, as Karl Marx says, when the supply of something increases, its price falls. In other words, if China had a more normal amount of reserve holdings, the value of the dollar would fall, increasing the competitiveness of U.S. goods and services, thereby reducing the trade deficit.

At the beginning of the piece, Porter discusses the question of China's currency "manipulation." (I would much prefer the more neutral and accurate term "currency management." There is nothing very secret here.) He tells readers:

"It would be hard, these days, to find an economist who feels China fits the bill."

Perhaps. Of course it would have been difficult to find an economist who recognized the $8 trillion housing bubble, the collapse of which wrecked the economy. As the saying goes, "economists are not very good at economics."

* https://www.nytimes.com/2017/04/11/business/economy/trump-china-currency-manipulation-trade.html

-- Dean Baker

[Apr 12, 2017] Should France leave the EU, would euros held by, say, someone in Italy then become worthless?

Apr 12, 2017 | economistsview.typepad.com
Anachronism -> anne... , April 12, 2017 at 04:58 AM
Dr Krugman ignored another wrinkle in France leaving the euro; the euro itself.

While GB joined the EU, it retained the british pound. So, Brexit won't affect it monetarily. France, on the other hand, did convert to the euro (in hindsight, another enormous mistake). Each euro has an identifier, similar to how we designate the origin by Fed Reserve, which designates it's country of origin.

So, should France leave the EU, would euros held by, say, someone in Italy then become worthless? This isn't someone most people concern themselves with. When was the last time someone on this blog check to see which dollars in your wallet came from the Denver Fed? But, it may well be that the EU would stop honoring French euros, should they leave.

What a mess.

anne -> Anachronism... , April 12, 2017 at 05:18 AM
Interesting conjecture, but a Euro printed in France belongs to the Euro Area rather than to France in the same way that a dollar printed in Denver belongs to the United States. There is by the way, to my understanding, no treaty provision describing how any country in the Euro Area might leave.
pgl -> Anachronism... , April 12, 2017 at 05:42 AM
"Start with the euro. The single currency was and is a flawed project, and countries that never joined – Sweden, the UK, Iceland – have benefited from the flexibility that comes from independent currencies. There is, however, a huge difference between choosing not to join in the first place and leaving once in."

What did he ignore again?

pgl -> Anachronism... , April 12, 2017 at 05:43 AM
"should France leave the EU, would euros held by, say, someone in Italy then become worthless?"

They could readily convert existing Euros into Francs. This is the reverse of what they did in 1999.

Peter K. -> pgl... , April 12, 2017 at 08:27 AM
PGL thinks France can easily convert Euros into Francs or Germany can convert its Euros into DMs?

That would blow up the monetary union.

What a nut bar.

pgl -> Peter K.... , April 12, 2017 at 09:26 AM
"That would blow up the monetary union."

Oh gee - the end of the Euro would be the end of the universe. My internet stalker writes another incredibly stupid comment.

Peter K. -> pgl... , April 12, 2017 at 09:53 AM
" My internet stalker writes another incredibly stupid comment."

Shut up, old man. Stick to the subject at hand. Oh right you WANT to change the subject with insults.

Peter K. -> Anachronism... , April 12, 2017 at 08:29 AM
"So, should France leave the EU..."

Even if Greece left it would cause turmoil in the financial markets. That's the known unknown people are focused on to start the next crisis.

[Apr 12, 2017] What is the conceptual difference between the monetary base and outside money ?

Apr 12, 2017 | economistsview.typepad.com
Lee A. Arnold April 12, 2017 at 03:02 AM

A question, for anyone: What is the conceptual difference between the "monetary base" and "outside money"? pgl -> Lee A. Arnold ... , April 12, 2017 at 05:40 AM
Outside money is money that is not a liability for anyone "inside" the economy. Think gold and silver.

The monetary base represents bank reserves and cash which are liabilities of the FED.

Lee A. Arnold -> pgl... , April 12, 2017 at 06:23 AM
Okay, but then the bank reserves which are held at the Fed by law could be defined as part of "outside money", because they aren't backed by anything in the private economy. Those reserves are established, or insisted upon, by government fiat, in essence. We know those reserves are not really backed by a precious metal or anything else but faith. So why are bank reserves held at the Fed not included in the definition of "outside money"?
RGC -> Lee A. Arnold ... , April 12, 2017 at 07:08 AM
From the standpoint of the private economy, reserves are 'outside money", because they circulate only within the Fed system. Currency is inside money because it circulates within the private economy, although it also circulates between government and private banks.

The monetary base is both currency and reserves.

So it takes a clear understanding of the purpose of the discussion and maybe even a Venn diagram.

Lee A. Arnold -> RGC... , April 12, 2017 at 09:13 AM
According to the definitions I can find, cash notes and coins (currency) are "outside money", even though they circulate within the private economy.
pgl -> RGC... , April 12, 2017 at 09:24 AM
You are using a different definition of "outside" here.
RGC -> pgl... , April 12, 2017 at 10:03 AM
How about this:

Outside money is money that is either of a fiat nature (unbacked) or backed by some asset that is not in zero net supply within the private sector of the economy.

Thus, outside money is a net asset for the private sector. The qualifier outside is short for (coming from) outside the private sector.

Inside money is an asset representing, or backed by, any form of private credit that circulates as a medium of exchange.

Since it is one private agent's liability and at the same time some other agent's asset, inside money is in zero net supply within the private sector.

The qualifier inside is short for (backed by debt from) inside the private sector.

https://minneapolisfed.org/research/SR/SR374.pdf

JF -> Lee A. Arnold ... , April 12, 2017 at 08:57 AM
Reserves established by govt fiat????

These are entries in accounts owned by the banks and put there by the banks and are money. These can not be 'taken' by the govt without compensation per law.

Govt fiat money created these??? No.

What concerns you?

pgl -> JF... , April 12, 2017 at 09:25 AM
Good point and the right question.
Lee A. Arnold -> JF... , April 12, 2017 at 09:53 AM
JF, Sorry, I only meant that the minimum reserves are established by the decree of the public-private partnership known as the central bank. So I was using "fiat" in the sense of "law". I should not have written that the bank reserves are established by gov't "fiat" in a discussion about money, because that is confusing.

And the reason for this law is to make sure that banks can cover their needs for cash, to prevent a run on the banking system.

But what this means, is that the ultimate foundation of part of the individual's trust in the money that is used, is based upon the existence of the requirement for bank reserves. Otherwise, people wouldn't trust the money supply. The trust is not based on any function more basic than bank reserves.

What else do people trust? Well of course people already trust paper notes and coins in daily transactions: they automatically suppose that the gov't backs it up. Backs it up, with what?, they do not know; but it works. And for checks and debits, they suppose that the bank is good for the cash -- which ultimately is based on the reserve requirement. So therefore, "trust" of money by the common folk is presently based upon 2 things, the existence of currency and the (vaguely understood yet reassuring) existence of bank reserves.

Well, the "money base" is defined as reserves + cash & coin. However, this seems to me to be the same definition as "outside money". So I am still wondering if there is another difference between the definitions.

Certainly people think of gold & silver as money, but if that is the only difference between "monetary base" and "outside money", I think it would be easy to alter the definition of "currency" to include them.

pgl -> Lee A. Arnold ... , April 12, 2017 at 09:24 AM
Of course banks reserves are not backed by gold. Gold is outside money - reserves are different.

But the FED does record them as a liability. Are you saying the FED is made up of Martians or what?

Not sure why you are confusing what appears to be a very simple distinction.

Peter K. -> pgl... , April 12, 2017 at 09:52 AM
"Not sure why you are confusing what appears to be a very simple distinction."

Not everyone is as smart as the pompous PGL the Facile!

[Apr 09, 2017] As soon as regulators relax their vigilance banks start feckless expansion

Notable quotes:
"... Probably the biggest single factor was public employment was savagely cut during the Obama presidency which would have kept economic activity higher at a fairly cheap cost. ..."
"... the owning/lending class tends to dislike inflation for some reason... ..."
"... I think this is highly dependent on one's understanding of "equitable". Monetary policy can be used in a way that ensures safe income streams to those who already own many financial assets. Some people think that is how it should be and therefore "equitable". ..."
Apr 09, 2017 | economistsview.typepad.com
RGC -> RGC... April 08, 2017 at 07:17 AM

As John Kenneth Galbraith remarked:

"The central bank remains important for useful tasks - the clearing of checks, the replacement of worn and dirty banknotes, as a loan source of last resort. These tasks it performs well.

With other public agencies in the United States, it also supervises the subordinate commercial banks. This is a job which it can do well and needs to do better. In recent years the regulatory agencies, including the Federal reserve, have relaxed somewhat their vigilance. At the same time numerous of the banks have been involved in another of the age-old spasms of optimism and feckless expansion. The result could be a new round of failures. It is to such matters that the Federal Reserve needs to give its attention.

These tasks apart, the reputation of central bankers will be the greater, the less responsibility they assume. Perhaps they can lean against the wind - resist a little and increase rates when the demand for loans is persistently great, reverse themselves when the reverse situation holds.

But, in the main, control must be - as it was in the United States during the war years and the good years following - over the forces which cause firms and persons to seek loans and not over whether they are given or not given the loans."

-From "Money: Whence it came,Where it went" 1975 - pgs 305,6.

RGC -> RGC... , April 08, 2017 at 07:33 AM
[Mariner Eccles explained it way back in the 1930's:]

"Pushing on a String: An Origin Story

There's a long-standing metaphor in monetary policy that the central bank "can't push on a string." It means that while a central bank can certainly slow down an economy or even drive an economy into recession with an ill-timed or too-large increase interest rates, the power of monetary policy is not symmetric.

When a central bank reduces interest rates in an attempt to stimulate the economy, it may not make much difference if banks don't think it's a good time to lend or firms and consumers don't think it's a good time to borrow. In other words, monetary policy is like a string with which a central bank can "pull" back the economy, but pushing on a string just crumples the string.

The "can't push on a string" metaphor appears in many intro-level economics texts. It has also gotten a heavy work-out these last few years as people have sought to understand why either economic output or inflation wasn't stimulated more greatly by having the Federal Reserve's target interest rate (the "federal funds" rate) near zero percent for going on seven years now, especially when combined with "forward guidance" promises that this policy would continue into the future and a couple trillion dollars of direct Federal Reserve purchases of Treasury debt and mortgage-backed securities.

The first use of "pushing on a string" in a monetary policy context may have occurred in hearings before House Committee on Banking and Currency on March 18, 1935, concerning the proposed Banking Act of 1935. Marriner Eccles, who was appointed Chairman of the Fed in 1934 and served on the Board of Governors until 1951, was taking questions from Rep. Thomas Alan Goldsborough (D-MD) and Prentiss M. Brown (D-MI). The hearings are here; the relevant exchange is on p. 377, during a discussion of what the Fed might be able to do to end deflation."

http://conversableeconomist.blogspot.com/2015/07/pushing-on-string-origin-story.html

Peter K. -> RGC... , April 08, 2017 at 08:05 AM
The Fed didn't try very hard with its unconventional monetary policy. It was always worried about inflation. Plus it had to overcome the unprecedented austerity which Congress pushed on the economy.

If you look at the recovery and say monetary policy didn't work, you are either insane or highly ideological.

Now, the recovery could have been much quicker and better with the help of fiscal policy and other policies.

RC AKA Darryl, Ron said in reply to RGC... , April 08, 2017 at 09:14 AM
Thx.

OK, this is a joke =

We are all quantity of money theory people now.

Must be so, because the following certainly is not true =

"We are all Keynesians now"

OK, not all one way or the other but the Keynesians are under siege by monetarists including ones that do not know what a monetarist is or that they are one.

RC AKA Darryl, Ron said in reply to RC AKA Darryl, Ron... , April 08, 2017 at 09:28 AM
It is not that monetary policy is entirely ineffective at stimulating demand, but that its effects are very limited according to the very narrow channels in which its effects are most pronounced, intermediation risks, widening the term spread or yield curve, and making short term business loans and related prime rate small short term loans. It does next to nothing towards reducing credit rationing by financial institutions after a shock, which would be highly stimulative compared to just lowering the FFR. Purchase of the riskiest assets by the Fed was probably most effective at reducing credit rationing since it lowered the risk of bank loan portfolios. Just buying up safe assets had mixed results on lowering long term interest rates, but was more successful on that than reducing credit rationing.
RC AKA Darryl, Ron said in reply to RC AKA Darryl, Ron... , April 08, 2017 at 09:30 AM
Since the FFR was at the ZLB, further lowering long term interest rates also flattened the yield curve.
Peter K. -> RC AKA Darryl, Ron... , April 08, 2017 at 10:27 AM
All your jargon obscures the point that the Fed didn't really try that hard with its unconventional policy b/c of politics.

It's like arguing that the ARRA didn't work very well. It did work and could have been bigger and better but policymakers are too conservative when it comes to macro policy.

RGC -> RC AKA Darryl, Ron... , April 08, 2017 at 09:29 AM
Subtle..... I think.
Peter K. -> RC AKA Darryl, Ron... , April 08, 2017 at 10:29 AM
Again you're muddying the issue. It's not really monetarists versus Keynesians.

It's these know-nothing lefties who think that tight money doesn't matter.

RC AKA Darryl, Ron said in reply to Peter K.... , April 08, 2017 at 11:35 AM
Tight money means credit rationing. Cheap money does not necessarily get looser. Yes, widening the term spread helps loosen, but narrowing the term spread does not. Other forms of monetary policy such as government loan guarantees on small business loans loosen money more than QE.
Peter K. -> RGC... , April 08, 2017 at 08:01 AM
"Monetary policy has always been ineffective in stimulating demand"

Simply not true.

RGC -> Peter K.... , April 08, 2017 at 08:11 AM
As I've told you before, I see no point in arguing the issue with you.
Peter K. -> RGC... , April 08, 2017 at 08:28 AM
Because you're wrong and misleading. The Fed does the minimal amount of experimental unconventional policy - always paranoid over inflation - while Congress forces unprecedented fiscal austerity on the economy. I'd say monetary policy works. Doesn't mean fiscal policy doesn't work better.
Peter K. -> Peter K.... , April 08, 2017 at 08:41 AM
"Now here we are, in 2017, after the Obama Administration has brought the deficit down from $1.5 trillion in Fiscal Year 2009 to $621 billion in FY2016, "

Via Max Sawicky, below. $900 billion in austerity that monetary policy had to fight against.

Pinkybum -> Peter K.... , April 08, 2017 at 09:25 AM
I don't think it is as simple as you have outlined here. Debt as a percentage of GDP has doubled since 2009 so that has provided some relief. Probably the biggest single factor was public employment was savagely cut during the Obama presidency which would have kept economic activity higher at a fairly cheap cost.
Peter K. -> Pinkybum... , April 08, 2017 at 10:24 AM
"Debt as a percentage of GDP has doubled since 2009 so that has provided some relief."

wut?

The largest difference was there was little to no Federal aid to the states which had to run balanced budgets.

We can all agree after the ARRA ran its course, there was massive, unprecedented austerity forced on the economy by Republicans, just as in the UK and we see the results when central banks didn't do enough unconventional policy to fully offset it.

A crappy recovery and the election of Trump/Brexit.

RGC -> Peter K.... , April 08, 2017 at 09:18 AM
Because I know you won't change your mind and you can't resist getting personal.
Peter K. -> RGC... , April 08, 2017 at 10:24 AM
You just repeat the same quotes over and over again as if that will change anyone's minds.
RGC -> Peter K.... , April 08, 2017 at 10:36 AM
This is exactly why I don't want to discuss the issue with you. You never address the issue and you make a personal remark.
Peter K. -> RGC... , April 08, 2017 at 10:48 AM
I never address the issue? All you do is repeat quotes form men who have long since died.
RC AKA Darryl, Ron said in reply to Peter K.... , April 08, 2017 at 11:36 AM
Men rather than mice though.
yuan -> RGC... , April 08, 2017 at 09:58 AM
monetary policy can redistribute capital in a more equitable manner. are you opposed to this? do you think the rich deserve their gains?
RGC -> yuan... , April 08, 2017 at 10:41 AM
I think your statement is erroneous. Show me how "monetary policy can redistribute capital in a more equitable manner." and we could discuss it.
yuan -> RGC... , April 08, 2017 at 11:11 AM
the owning/lending class tends to dislike inflation for some reason...
Jerry Brown said in reply to RGC... , April 08, 2017 at 11:19 AM
I think this is highly dependent on one's understanding of "equitable". Monetary policy can be used in a way that ensures safe income streams to those who already own many financial assets. Some people think that is how it should be and therefore "equitable".

I have no idea how monetary policy with its currently defined policy tools can be used effectively, by itself, to redistribute wealth in the other direction, which is probably most people's understanding of "equitable".

If it was, by itself, able to cause large jumps in inflation, that might feed back into rapidly rising nominal wages and large losses to the current holders of financial assets like bonds and loan books. That might be considered more "equitable" to some, but current limitations on monetary policy prevent it from creating inflation all by itself.

RGC -> Jerry Brown... , April 08, 2017 at 11:34 AM
I like your understanding of "equitable" better.

[Apr 08, 2017] A new study suggests that near-zero interest rates - accompanied by a lackluster recovery - may become a common occurrence.

Notable quotes:
"... When the Federal Reserve lowered interest rates to close to zero during the financial crisis, it was an extraordinary move. The central bank had hit the limits of conventional monetary policy, leaving the recovery to sputter along with less help than it needed ..."
"... A new study suggests that near-zero interest rates - accompanied by a lackluster recovery - may become a common occurrence. ..."
Apr 08, 2017 | www.nytimes.com

Peter K., Saturday, April 08, 2017 at 08:21 AM

https://www.nytimes.com/2017/04/07/upshot/the-economy-may-be-stuck-in-a-near-zero-world.html?partner=rss&emc=rss&_r=1

" When the Federal Reserve lowered interest rates to close to zero during the financial crisis, it was an extraordinary move. The central bank had hit the limits of conventional monetary policy, leaving the recovery to sputter along with less help than it needed ."

This is a huge lie. The Fed did not do what it could have done. It did the minimal amount possible, always afraid of setting off inflation. The Fed said it delivered the recovery it wanted. It gave the economy exactly the help the Fed thought it needed. Then why the dishonesty from Wulfers. It's the kind we get from PGL the Facile.

Why did the Fed deliver a lame recovery is the question Wolfers should be asking, but it's the kind of thing mainstream economists like him and PGL avoid. It's class war.

" A new study suggests that near-zero interest rates - accompanied by a lackluster recovery - may become a common occurrence.

That's troubling for many reasons. If the Fed can't cut rates as much as required to fight a slowing economy, then recessions will become more common and more painful. It suggests an urgent need to reconsider how we will counter the next bout of bad economic news, preferably before it arrives. If monetary policy won't be enough, perhaps fiscal policy will be. Certainly, this is no time for complacency."

Yes fiscal policy would help deliver a better recovery as the Fed has repeatedly said, but again Wolfers is misleading his readers. The Fed could do more. It's not out of bullets. It's raising rates. Wolfers is really doing a disservice to his readers in an apparent attempt to talk up fiscal policy in a dishonest way. WTF.

"But when normal interest rates are closer to 3 percent, the Fed can cut rates only a few times, because rates can only go so low - perhaps as low as zero, maybe a tad lower. This means that in even a typical downturn, the Fed may be unable to cut rates as much as it would like."

But then it turns to unconventional policy. Seriously. WTF.

"This dynamic can feed on itself. The less ammunition the Fed has to blast the economy out of its malaise, the weaker and slower will be the recovery, making it more likely that the next bad shock will require the Fed to cut rates more than is feasible."

It doesn't have less ammunition. Now Wolfers finally admits there's something called unconventional policy.

"The Fed has already been experimenting with monetary policy, but it hasn't been enough. In the wake of the financial crisis, for example, it bought bonds in a program known as quantitative easing, cutting long-term interest rates once short-term rates were near zero. The resulting stimulus was relatively small, reducing long-term rates by only a fraction of a percentage point, and the program was politically unpopular.

The authors suggest an alternative approach in which the Fed makes up for "missing stimulus" by promising to keep rates lower, for longer periods. In their view, the Fed needs to make up for the interest rate cuts that it wishes it could have made, but couldn't. Promising this in the depths of a downturn would offer businesses reason to be optimistic, they say, boosting the recovery. The Fed would need to keep rates low, even as inflation overshot its target.

It's a promising approach, but would people really believe the Fed's promises? I know a lot of central bankers, and I fear they are incapable of sitting still while inflation rises above their stated target."

Wolfers admits that central bankers haven't pushed very hard on unconventional policy, shattering his thesis. They're paranoid over inflation.

"Perhaps the answer lies outside the Fed. It may be time to revive a more active role for fiscal policy - government spending and taxation - so that the government fills in for the missing stimulus when the Fed can't cut rates any longer. Given political realities, this may be best achieved by building in stronger automatic stabilizers, mechanisms to increase spending in bad times, without requiring Congressional action."

That's a good idea no matter whether unconventional monetary policy works or not. But Republicans are blocking it, so monetary policy is all we have. It doesn't help to say it doesn't work and we must suffer long painful recoveries.

"The general distrust of fiscal policy may well have made sense; many economists are more likely to trust the technocrats at the Fed to manage the business cycle than the election-driven politicians on Capitol Hill. But in a world of low interest rates in which the Fed is frequently hamstrung, we may not have that choice."

No the sidelining of fiscal policy never made any sense. But that doesn't mean we should sideline monetary policy when fiscal policy isn't forthcoming.

Alt facts from Wolfers.

libezkova -> Peter K.... April 08, 2017 at 03:15 PM

"A new study suggests that near-zero interest rates - accompanied by a lackluster recovery - may become a common occurrence."

That's another way to spell "end of cheap oil"

[Apr 08, 2017] Reply

Apr 08, 2017 | onclick="TPConnect.blogside.reply('6a00d83451b33869e201b8d2758ec5970c'); return false;" href="javascript:void 0">
Saturday, April 08, 2017 at 09:58 AM RGC said in reply to yuan... I think your statement is erroneous. Show me how "monetary policy can redistribute capital in a more equitable manner." and we could discuss it. Reply Saturday, April 08, 2017 at 10:41 AM yuan said in reply to RGC... the owning/lending class tends to dislike inflation for some reason... Reply Saturday, April 08, 2017 at 11:11 AM Jerry Brown said in reply to RGC... I think this is highly dependent on one's understanding of "equitable". Monetary policy can be used in a way that ensures safe income streams to those who already own many financial assets. Some people think that is how it should be and therefore "equitable".

I have no idea how monetary policy with its currently defined policy tools can be used effectively, by itself, to redistribute wealth in the other direction, which is probably most people's understanding of "equitable".

If it was, by itself, able to cause large jumps in inflation, that might feed back into rapidly rising nominal wages and large losses to the current holders of financial assets like bonds and loan books. That might be considered more "equitable" to some, but current limitations on monetary policy prevent it from creating inflation all by itself. Reply Saturday, April 08, 2017 at 11:19 AM RGC said in reply to Jerry Brown... I like your understanding of "equitable" better. Reply Saturday, April 08, 2017 at 11:34 AM

[Apr 04, 2017] I am shocked, shocked to find that gambling is going on in here!

Notable quotes:
"... Casablanca, ..."
Apr 04, 2017 | www.businessinsider.com

Rick: How can you close me up? On what grounds?

Captain Renault: I'm shocked, shocked to find that gambling is going on in here!

– From the classic scene in Casablanca, made in 1942

Casablanca

The latest scandal du jour seems to be about what is now called LIBORgate. But is it a scandal or is it really just business as usual?

And if we don't know which it is, what does that say about how we organize the financial world, in which $300-800 trillion, give or take, is based on LIBOR?

This is actually just the second verse of the old song about derivatives, which is a much larger market. Which of course is a problem that was not solved by Dodd-Frank and that has the potential to once again create true havoc with the markets, whereas LIBOR can only cost a few billion here and there. (Sarcasm intended.)

The problem is the lack of transparency. Why would banks want to reveal how much profit they are making? The last thing they want is transparency. This week I offer a different take on LIBOR, one which may annoy a few readers, but which I hope provokes some thinking about how we should organize our financial world.

There Is Gambling in the House? I Am Shocked...

Let's quickly look at what LIBOR is. The initials stand for London InterBank Offered Rate. It is the rate that is based on what 16 banks based in London (some are US banks) tell Thomson Reuters they expect to pay for overnight loans (and other longer loans). Thomson Reuters throws out the highest four numbers and the lowest four numbers and then gives us an average of the rest. Then that averaged number becomes about 150 other "rates," from overnight to one year and in different currencies. The key is that the number is not what the banks actually paid for loans, it's what they expect to pay. Also, please note that the British Banking Association, on its official website, calls this a price "fixing."

Most of the time the number is probably pretty close to real, or close enough for government work. But then, there are other times when it is at best a guess and at worst manipulated.

Back in the banking and credit crisis panic of 2008 the interbank market dried up. No bank was loaning other banks any money at any price. Thus there was clearly no way for the LIBOR number to be anything but fictitious. Anyone who was not aware of this was simply not paying attention.

The regulators certainly knew on both sides of the Atlantic. All along there were clear records, we now learn, that bankers were telling the FSA (the Financial Services Authority) that they had problems. Regulators were worried about what was happening but were pointing out that there was a large hole in the ship that was already admitting water, and they didn't want to make it any bigger. Timothy Geithner, then President of the New York Federal Reserve Bank (and now Secretary of the Treasury) wrote a rather pointed letter to the FSA, suggesting the need for better practices.

Some banks reported lower rates, to make it appear they were better off than they were (since no one was actually lending to them), and others might have given higher rates, for other reasons. Remember, this was a British Banking Association number. Whether you personally won or lost money on the probably wrong price information depends on whether you were lending or borrowing and whether you really wanted the entire market to appear worse than it already was.

This was the equivalent of an open-book test where you got to grade your own paper. And we are supposed to be shocked that there might have been a few bad "expectations" here and there by bankers acting in their own self-interest, with the knowledge of the regulators? The more amazing proposition would be that in a time of crisis the number had any close bearing on reality to begin with. Call me skeptical, but I fail to see how we should be surprised.

The larger question that really needs to be asked is how in the name of all that is holy did we get to a place where we base hundreds of trillions of dollars of transactions worldwide on a number whose provenance is not clearly transparent. Yes, I get that the methodology of the creation of the number after the banks call in their "expectations" is clear, but the process of getting to that number was evidently not well understood and looks to be even muddier than my rather cynical previous understanding of it.

It now seems that there will be a feeding frenzy as politicians and regulators hammer the various banks for improper practices. And they are pretty easy targets: there is just no way you can explain this that does not sound bad.

You're a big banker. The world is falling down before your eyes. No one trusts anyone. If you put out a bad number (whatever "bad" means in a time of sheer utter blind panic) the markets will kill you even more than they already are and you could lose your job. You have got to come up with a number in ten minutes.

"Hey, Nigel, what do you think we should tell Tommie [Thomson Reuters]?"

"I don't know, Winthorpe, maybe Mortimer has an idea; let's ask him."

Simply fining a few bankers is not going to fix the larger problem: the lack of transparency for arguably the most important number in financial markets. A very clear methodology needs to be developed, along with guidelines for what to do in times of crisis when the interbank market is frozen and there really is no number. Having no number might be worse than having a number that is a guess. But having a number that can be fudged by banks for their benefit is also clearly not in the public's interest.

The point of the rule of law is that it is supposed to level the playing field. But the rule of law means having a very transparent process with very clear rules and guidelines and penalties for breaking the rules.

I had dinner with Dr. Woody Brock this evening in Rockport. We were discussing this issue and he mentioned that he had done a study based on analysis by an institution that looks at all sorts of "fuzzy" data, like how easy it is to start a business in a country, corporate taxes and business structures, levels of free trade and free markets, and the legal system. It turned out that the trait that was most positively correlated with GDP growth was strength of the rule of law. It is also one of the major factors that Niall Ferguson cites in his book Civilization as a reason for the ascendency of the West in the last 500 years, and a factor that helps explain why China is rising again as it emerges from chaos.

One of the very real problems we face is the growing feeling that the system is rigged against regular people in favor of "the bankers" or the 1%. And if we are honest with ourselves, we have to admit there is reason for that feeling. Things like LIBOR are structured with a very real potential for manipulation. When the facts come out, there is just one more reason not to trust the system. And if there is no trust, there is no system.

Opacity and Credit Default Swaps

Which brings me to my next point. We just went through a crisis where derivatives were a major part of the problem, and specifically the counterparty risk of over-the counter (OTC) derivatives.

Taxpayers had to back-stop derivatives sold by banks (and specifically AIG ) that were clearly undercapitalized. That cost tens of billions. Yet the commissions and bonuses paid for selling those bad derivatives went on being paid. Congress held hearings and expressed outrage, but in the end Dodd-Frank sold out.

"Efforts to create an exchange-traded futures contract tied to credit-default swaps haven't yet gained traction after 18 months of talks, but banks dealing in the private multitrillion-dollar market for credit derivatives believe such contracts will eventually appear for a simple reason: They should attract new players.

"Credit-default swaps function like insurance for bonds and loans. Investors use them to hedge or speculate against changes in a borrower's creditworthiness. If a borrower defaults, sellers of the protection compensate buyers.

"The swaps – traded over the phone or on-screen, with prices known only to trading partners – are the domain of asset managers and hedge funds with the sophistication and financial wherewithal to take on complex risks.

"Futures, by contrast, are more routine instruments used by institutions and individual or "retail" investors. Futures prices are displayed publicly on exchanges, and customers can trade them directly with other customers – unlike in the swaps market, where a dealer is on one side of every trade.

"Dealers have long been fiercely protective of keeping the status quo in credit-default swaps or 'CDS' because they have booked fat profits from customers not being able to see where other customers are trading." (Market Watch)

And that is the issue. Bankers do not want transparency, because it will seriously cut into their profits. And while I like everyone to make a profit, the implicit partner in every trade is the taxpayer and, last time I looked, we do not get a piece of that trade. Derivatives traded on an exchange were not part of the problem during the last credit crisis; OTC derivatives were.

An exchange makes it very clear where the counterparty risk is and what the price mechanism is. It creates a transparent rule of law and places the risk on the backs of those buying and selling derivatives and not on the taxpayer. Exchange-traded derivatives do not pose a potential threat to the economies of the world, while we don't know the extent of the threat posed by OTC trades. JPMorgan has lost around $6 billion on the trading of their "London Whale." If Jamie Dimon and the JPM board couldn't guarantee reasonable corporate governance, then why should we assume that in another crisis we won't find another AIG?

Dodd-Frank needs to be repealed and replaced. The last time, the process was too clearly in the hands of those being regulated and has contributed to their profits. Enough already.

Credit default swaps and any other derivative large enough to put the system at risk must be moved to an exchange, to make clear the counterparty risks.

[Apr 04, 2017] The Production of Money

This FT -- the most deep neoliberal swamp among mainstream newspaper. So they do not like any critique of thier beloved neloneral world order with the dominance of reckless financial oligarchy as one of the key components.
Notable quotes:
"... She argues that under our deregulated financial system "commercial bankers can create credit . . . effectively without limit, and with few regulatory constraints." She says that because the government and central banks impose no restrictions on what credit is used for, banks increasingly lend for speculative activities, rather than "sound, productive investment". ..."
"... The collateral for this borrowing is in the form of "promises to pay", which can "evaporate" and be defaulted upon - which risks dragging down the rest of the system. ..."
"... many of the remedies Pettifor recommends are, as she acknowledges, fairly mainstream: monitoring the evolution of credit relative to national income, limiting loan-to-value mortgage ratios more strictly, imposing stronger regulation on banks and issuing government debt at low interest rates across the maturity spectrum. ..."
"... Less mainstream are her calls for controls on international capital flows through a Tobin tax on financial transactions, and for central banks to "manage exchange rates over a specified range by buying and selling currency". ..."
"... its confrontational style - criticising financial market players, most economists, politicians and ideas from other left-leaning economists ..."
Apr 04, 2017 | economistsview.typepad.com
Peter K. , April 03, 2017 at 01:38 PM
https://www.ft.com/content/40b5b516-152c-11e7-b0c1-37e417ee6c76

'The Production of Money', by Ann Pettifor - a financial education

16 HOURS AGO by: Review by Gemma Tetlow

Ann Pettifor's The Production of Money, is a work in three parts. It provides an explanation of how money and credit are created in modern economies and of some of the problems that helped foment the financial crisis. The author, an economist, then sets out her views on how these problems should be fixed, including introducing controls on international capital flows. Finally, and less obviously from the title, the book strays into a critique of fiscal austerity.

"Citizens," Pettifor argues, "were unprepared for the [financial] crisis, and remain on the whole ignorant of the workings of the financial system." This is one reason why policymakers have failed to address its failings. One of her objectives is to "simplify key concepts in relation to money, finance and economics, and to make them accessible to a much wider audience".

Chapter two provides a clear, intuitive explanation of how money is created and how this can facilitate economic growth. Money creation is a complex and intangible concept in a world where it is no longer backed by gold bars held by the central bank, and Pettifor provides the most accessible and thorough explanation I have seen.

In the rest of the book, the author sets out her diagnosis of the problems afflicting the world's monetary system and her prescription for how they should be fixed. She argues that under our deregulated financial system "commercial bankers can create credit . . . effectively without limit, and with few regulatory constraints." She says that because the government and central banks impose no restrictions on what credit is used for, banks increasingly lend for speculative activities, rather than "sound, productive investment".

The collateral for this borrowing is in the form of "promises to pay", which can "evaporate" and be defaulted upon - which risks dragging down the rest of the system.

The description is informative as far as it goes. However, it does not provide the sort of compelling, insightful account of the problems before the crisis that is provided by, for example, Michael Lewis in The Big Short.

She strikes a revolutionary tone when setting out the problem. But many of the remedies Pettifor recommends are, as she acknowledges, fairly mainstream: monitoring the evolution of credit relative to national income, limiting loan-to-value mortgage ratios more strictly, imposing stronger regulation on banks and issuing government debt at low interest rates across the maturity spectrum.

Less mainstream are her calls for controls on international capital flows through a Tobin tax on financial transactions, and for central banks to "manage exchange rates over a specified range by buying and selling currency".

Her support for these measures is consistent with her belief - expressed throughout the book - that everything was well until the global financial system began to liberalise following the breakdown of the Bretton Woods system in 1971.

The evidence she provides to support her belief that policies in place during the Bretton Woods era were superior to those operating now appears rather selective. She cites data presented in Carmen Reinhart and Kenneth Rogoff's book, This Time is Different, as evidence that "financial crises proliferated" after the 1970s. However, Reinhart and Rogoff's thesis was that we have been here before in centuries past - and will be again.

The Production of Money presents one view of issues afflicting the world's financial systems and how they should be dealt with, and will be useful to readers unfamiliar with these issues. But in other places it provides a partial or rather confusing descriptions of aspects of the monetary system. Saying the global economy "is once again at risk of slipping into recession" and faces "deflation" are statements that have aged badly.

This book will help the public "develop a much greater understanding" of how banking and financial systems work. However, its confrontational style - criticising financial market players, most economists, politicians and ideas from other left-leaning economists - may put some readers off before they get to the meat of the argument. The characterisations of these groups' views are selective and her criticisms are at times not well supported by the evidence she presents.

[Mar 23, 2017] The Credit Theory of Money

Mar 23, 2017 | economistsview.typepad.com
tjfxh :

Reply Tuesday, March 21, 2017 at 04:15 PM , March 21, 2017 at 04:15 PM
David Graeber, Debt: The First 5000 Years. Melville House; Updated Expanded edition (2014).

Michael Hudson and Marc Van De Mieroop, Debt and Economic Renewal in the Ancient Near East. Capital Decisions Ltd (2002).

Geoffrey Ingham, The Nature of Money. Polity (2004).

A. Mitchell Innes, "The Credit Theory of Money," The Banking Law Journal, Vol. 31 (1914), Dec./Jan., 151-168.

_____________, "What is Money?," The Banking Law Journal, Vol. 30 (1913), May. 377-409

L. Randall Wray, Theories of Money and Banking. Edward Elgar (2012)

______________, Understanding Modern Money:The Key to Full Employment and Price Stability. Edward Elgar (1998)

anne -> tjfxh ... , March 21, 2017 at 04:34 PM
https://www.community-exchange.org/docs/The%20Credit%20Theoriy%20of%20Money.htm

1914

The Credit Theory of Money
By A. Mitchell Innes

https://www.community-exchange.org/docs/what%20is%20money.htm

1913

What Is Money?
By A. MITCHELL INNES

[ I do appreciate these references. ]

[Mar 22, 2017] Economist's View How Money Made Us Modern

Mar 22, 2017 | economistsview.typepad.com
How Money Made Us Modern Patrick Kiger at National Geographic:
How Money Made Us Modern : About 9,500 years ago in the Mesopotamian region of Sumer, ancient accountants kept track of farmers' crops and livestock by stacking small pieces of baked clay, almost like the tokens used in board games today. One piece might signify a bushel of grain, while another with a different shape might represent a farm animal or a jar of olive oil.
Those humble little ceramic shapes might not seem have much in common with today's $100 bill, whose high-tech anti-counterfeiting features include a special security thread designed to turn pink when illuminated by ultraviolet light, let alone with credit-card swipes and online transactions that for many Americans are rapidly taking the place of cash.
But the roots of those modern modes of payment may lie in the Sumerians' tokens. ...

Posted by Mark Thoma on Tuesday, March 21, 2017 at 10:06 AM in Economics | Permalink Comments (10)

View blog reactions

--> -->
Comments Feed You can follow this conversation by subscribing to the comment feed for this post. Shah of Bratpuhr : , March 21, 2017 at 11:08 AM

Article ended with Bitcoin... otherwise, great story.
Shah of Bratpuhr -> Shah of Bratpuhr... , March 21, 2017 at 11:09 AM
Bitcoin is quite volatile vs USD.

https://btcvol.info/

tjfxh : , March 21, 2017 at 12:34 PM
The article is poorly researched. The author needs to read Innes, Graeber, Ingham, Wray and Hudson on the history of money from the perspective of credit instead of relying on Davies, who emphasizes commodity money and doesn't distinguish between bullion and chartal.
kthomas -> tjfxh ... , March 21, 2017 at 01:03 PM
....coffee. Was there nothing you agreed with?
tjfxh : , March 21, 2017 at 02:09 PM
I was speaking specifically of the early history in my comment, but the entire article was rather one-sided. The debated on the history and nature of money is nuanced and the author made it seem as through the article presents a definitive version. The audience to which it is addressed would not glean that from the article and would likely come away with a one-sided and simplistic perspective on the history and nature of money.
anne -> tjfxh ... , March 21, 2017 at 02:32 PM
Do set down any specific references when possible.
JohnH : , March 21, 2017 at 02:32 PM
Michael Hudson offers a wonderful piece on the ancient middle east, how they handled oppressive debt, and how, in the Anglo-Saxon word, the biblical word for debt got translated into 'sin.'

"From the actual people who study cuneiform records, 90% of which are economic, what we have surviving from Sumer and Babylonia, from about 2500 BC to the time of Jesus, are mainly marriage contracts, dowries, legal contracts, economic contracts, and loan contracts. Above all, loans....

The rulers had what we would call an economic model. They realized that every economy tended to become unstable as a result of compound interest. We have the training tablets that they trained scribal students with, around 1800 or 1900 BC. They had to calculate: How long does it take debt to double its size, at what we'd call 20% interest? The answer is 5 years. How does long it take to multiply four-fold? The answer is 10 years. How much to multiply 64 times? The answer is 30 years. Well you can imagine how fast the debts grew.

So they knew how the tendency of every society was that people would run up debts. Now when they ran up debts in Sumer and Babylonia, and even in in Judea in Jesus' time, they didn't borrow money from money lenders. People owed debts because they were in arrears: They couldn't pay the fees owed to the palace. We might call them taxes, but they actually were fees for public services. And for beer, for instance. The palace would supply beer and you would run up a tab over the year, to be paid at harvest time on the threshing floor. You also would pay for the boatmen, if you needed to get your harvest delivered by boat. You would pay for draught cattle if you needed them. You'd pay for water. Cornelia Wunsch did one study and found that 75% of the debts, even in neo-Babylonian times around the 5th or 4th century BC, were arrears.

Sometimes the harvest failed. And when the harvest failed, obviously they couldn't pay their fees and other debts. Hammurabi canceled debts four or five times during his reign. He did this because either the harvest failed or there was a war and people couldn't pay.

What do you do if you're a ruler and people can't pay? One reason they would cancel debts is that most debts were owed to the palace or to the temples, which were under the control of the palace. So you're canceling debts that are owed to yourself.

Rulers had a good reason for doing this. If they didn't cancel the debts, then people who owed money would become bondservants to the tax collector or the wealthy creditors, or whoever they owed money to. If they were bondservants, they couldn't serve in the army. They couldn't provide the corvée labor duties – the kind of tax that people had to pay in the form of labor. Or they would defect. If you wanted to win a war you had to have a citizenry that had its own land, its own means of support."
http://michael-hudson.com/2017/01/the-land-belongs-to-god/

pgl -> JohnH... , March 21, 2017 at 03:26 PM
"The focus of my talk today will be Jesus' first sermon and the long background behind it that helps explain what he was talking about and what he sought to bring about."

Glad you are researching the ancient history of monetary regimes. Especially since your research into monetary history over the past 150 years is so incredibly wrong.

tjfxh : , March 21, 2017 at 04:15 PM
David Graeber, Debt: The First 5000 Years. Melville House; Updated Expanded edition (2014).

Michael Hudson and Marc Van De Mieroop, Debt and Economic Renewal in the Ancient Near East. Capital Decisions Ltd (2002).

Geoffrey Ingham, The Nature of Money. Polity (2004).

A. Mitchell Innes, "The Credit Theory of Money," The Banking Law Journal, Vol. 31 (1914), Dec./Jan., 151-168.

_____________, "What is Money?," The Banking Law Journal, Vol. 30 (1913), May. 377-409

L. Randall Wray, Theories of Money and Banking. Edward Elgar (2012)

______________, Understanding Modern Money:The Key to Full Employment and Price Stability. Edward Elgar (1998)

anne -> tjfxh ... , March 21, 2017 at 04:34 PM
https://www.community-exchange.org/docs/The%20Credit%20Theoriy%20of%20Money.htm

1914

The Credit Theory of Money
By A. Mitchell Innes

https://www.community-exchange.org/docs/what%20is%20money.htm

1913

What Is Money?
By A. MITCHELL INNES

[ I do appreciate these references. ]

[Feb 19, 2017] Privilege: still exorbitant. An analysis of the international role of the dollar.

Notable quotes:
"... Privilege: still exorbitant. Here's a nice analysis of the international role of the dollar. This is the same argument I tried to make in my Roosevelt Institute piece on trade policy last summer. The Economist* says it better: ..."
"... "Unlike other aspects of American hegemony, the dollar has grown more important as the world has globalised, not less. As economies opened their capital markets in the 1980s and 1990s, global capital flows surged. Yet most governments sought exchange-rate stability amid the sloshing tides of money. They managed their exchange rates using massive piles of foreign-exchange reserves Global reserves have grown from under $1trn in the 1980s to more than $10trn today. ..."
"... Dollar-denominated assets account for much of those reserves. Governments worry more about big swings in the dollar than in other currencies; trade is often conducted in dollar terms; and firms and governments owe roughly $10trn in dollar-denominated debt. the dollar is, on some measures, more central to the global system now than it was immediately after the second world war. ..."
"... America wields enormous financial power as a result. It can wreak havoc by withholding supplies of dollars in a crisis. When the Federal Reserve tweaks monetary policy, the effects ripple across the global economy. Hélène Rey of the London Business School argues that, despite their reserve holdings, many economies have lost full control over their domestic monetary policy, because of the effect of Fed policy on global appetite for risk. ..."
"... America's return on its foreign assets is markedly higher than the return foreign investors earn on their American assets That flow of investment income allows America to run persistent current-account deficits -- to buy more than it produces year after year, decade after decade." ..."
Feb 19, 2017 | economistsview.typepad.com
Peter K. : February 18, 2017 at 06:50 AM
J.W. Mason has some interesting links at his blog:

http://jwmason.org/slackwire/links-and-thoughts-for-feb-17/

Privilege: still exorbitant. Here's a nice analysis of the international role of the dollar. This is the same argument I tried to make in my Roosevelt Institute piece on trade policy last summer. The Economist* says it better:

"Unlike other aspects of American hegemony, the dollar has grown more important as the world has globalised, not less. As economies opened their capital markets in the 1980s and 1990s, global capital flows surged. Yet most governments sought exchange-rate stability amid the sloshing tides of money. They managed their exchange rates using massive piles of foreign-exchange reserves Global reserves have grown from under $1trn in the 1980s to more than $10trn today.

Dollar-denominated assets account for much of those reserves. Governments worry more about big swings in the dollar than in other currencies; trade is often conducted in dollar terms; and firms and governments owe roughly $10trn in dollar-denominated debt. the dollar is, on some measures, more central to the global system now than it was immediately after the second world war.

America wields enormous financial power as a result. It can wreak havoc by withholding supplies of dollars in a crisis. When the Federal Reserve tweaks monetary policy, the effects ripple across the global economy. Hélène Rey of the London Business School argues that, despite their reserve holdings, many economies have lost full control over their domestic monetary policy, because of the effect of Fed policy on global appetite for risk.

During the heyday of Bretton Woods, Valéry Giscard d'Estaing, a French finance minister (later president), complained about the "exorbitant privilege" enjoyed by the issuer of the world's reserve currency. America's return on its foreign assets is markedly higher than the return foreign investors earn on their American assets That flow of investment income allows America to run persistent current-account deficits -- to buy more than it produces year after year, decade after decade."

Exactly right. You can have free capital mobility, or you can have a balanced trade for the US. But you can't have both, as long as the world depends on dollar reserves."

Darryl noted Keynes's Bancor.

https://en.wikipedia.org/wiki/Bancor

[Jan 23, 2017] re F@ck Work naked capitalism

Jan 23, 2017 | www.nakedcapitalism.com
By Scott Ferguson, Assistant Professor, University of South Florida. He is also a Research Scholar at the Binzagr Institute for Sustainable Prosperity. His current research and pedagogy focus on Modern Monetary Theory and critiques of neoliberalism, aesthetic theory; the history of digital animation and visual effects; and essayistic writing across media platforms. Originally published at Arcade

James Livingston has responded to my critique of his Aeon essay, " Fuck Work ." His response was published in the Spanish magazine Contexto y Accion . One can find an English translation here . What follows is my reply:

... ... ...

This brings me to Modern Monetary Theory (MMT). Far from an "obscure intellectual trend," MMT is a prominent heterodox school of political economy that emerged from post-Keynesian economics and has lately influenced the economic platforms of Bernie Sanders , Jeremy Corbyn , and Spain's United Left . For MMT, money is not a private token that states amass and hemorrhage. Rather, it is a boundless government instrument that can easily serve the needs of the entire community. International monetary agreements such the Eurozone's Maastricht Treaty may impose artificial limits on fiscal spending, but these are, MMT argues, political constraints. They are not economically inevitable and can immediately be dissolved. In truth, every sovereign polity can afford to take care of its people; most governments simply choose not to provide for everyone and feign that their hands are tied.

To be sure, Liberalism has debated the "designation and distribution of rival goods," as Livingston explains. In doing so, however, it has overlooked how macroeconomic governance conditions the production of these goods in the first place. MMT, by contrast, stresses money's creative role in enabling productive activity and places government's limitless spending powers at the heart of this process.

In lieu of Liberal "redistribution" via taxation, MMT calls for a politics of " predistribution ." Redistributive politics mitigate wealth disparity by purportedly transferring money from rich to poor. This is a false and deeply metaphysical gesture, however, since it mistakes the monetary relation for a finite resource instead of embracing government's actual spending capacities. MMT's predistributive politics, meanwhile, insist that government can never run out of money and that meaningful transformation requires intervening directly in the institutions and laws that structure economic activity. MMT does not imply a crude determinism in which government immediately commands production and distribution. Rather, it politicizes fiscal spending and the banking system, which together underwrite the supposedly autonomous civil society that Livingston celebrates.

MMT maintains, moreover, that because UBI is not sufficiently productive, it is a passive and ultimately inflationary means to remedy our social and environmental problems. It thus recommends a proactive and politicized commitment to public employment through a voluntary Job Guarantee . Federally funded yet operated by local governments and nonprofits , such a system would fund communal and ecological projects that the private sector refuses to pursue. It would stabilize prices by maintaining aggregate purchasing power and productive activity during market downturns. What is more, by eliminating forced unemployment, it would eradicate systemic poverty, increase labor's bargaining power, and improve everyone's working conditions. In this way, a Job Guarantee would function as a form of targeted universalism : In improving the lives of particular groups, such a program would transform the whole of economic life from the bottom up.

Unlike the Job Guarantee, UBI carries no obligation to create or maintain public infrastructures. It relinquishes capital-intensive projects to the private sector. It banks on the hope that meager increases in purchasing power will solve the systemic crises associated with un- and underemployment.

Let us, then, abandon UBI's "end of work" hysteria and confront the problem of social provisioning head on. There is no escape from our broken reality. We do better to seize present power structures and transform collective participation, rather than to reduce politics to cartoonish oppositions between liberty and tyranny, leisure and toil. Technology is marvelous. It is no substitute, however, for governance. And while civil society may be a site of creativity and struggle, it has limited spending abilities and will always require external support.

It is essential, therefore, to construct an adequate welfare system. On this matter, Livingston and I agree. But Livingston's retreat from governance strikes me as both juvenile and self-sabotaging. Such thinking distracts the left from advancing an effective political program and building the robust public sector we need.

Carlos , January 23, 2017 at 2:31 am

I really need to be kicked out of the house, to go someplace and do something I don't really want to do for 8 hours a day.

I've already got too much time to fritter away. I'm fairly certain, giving me more time and money to make my own choices would not make the world a better place.

Dogstar , January 23, 2017 at 7:44 am

Hmm. No "sarc" tag Really?? More free time and money wouldn't be a benefit to you and your surroundings? That's hard to believe. To each their own I guess.

MtnLife , January 23, 2017 at 8:39 am

I can see it both ways. Most people see that as sarcasm but I have more than a few friends whose jobs are probably the only thing keeping them out of jail. Idle hands being the devil's plaything and all. For instance, the last thing you want to give a recovering addict is a lot of free time and money.

Jonathan Holland Becnel , January 23, 2017 at 11:51 am

As a recovering addict, I must vehemently disagree with ur statement.

I would love to have as much money and free time on my hands to work on the fun hobbies that keep me sober like Political Activism, Blogging, Film, etc.

Marco , January 23, 2017 at 1:22 pm

Many MANY folks take drugs and alcohol specially BECAUSE of their jobs

JohnnyGL , January 23, 2017 at 10:46 am

At no point in the "Job Guarantee" discussion did anyone advocate forcing you to go to work. However, if you decide to get ambitious and want a paid activity to do that helps make society a better place to live, wouldn't it be nice to know that there'd be work available for you to do?

Right now, that's not so easy to do without lots of effort searching for available jobs and going through a cumbersome and dispiriting application process that's designed to make you prove how much you REALLY, REALLY want the job.

For me, the real silver bullet is the moral/political argument of a Job Guarantee vs. Basic Income. Job Guarantee gives people a sense of pride and accomplishment and those employed and their loved ones will vigorously defend it against those who would attack them as 'moochers'. Also, defenders can point to the completed projects as added ammunition.

Basic income recipients have no such moral/political defense.

jrs , January 23, 2017 at 1:04 pm

The guaranteed jobs could be for a 20 or 30 hour week. I fear they won't be as most job guarantee advocates seem to be Calvinists who believe only work gets you into heaven though.

skippy , January 23, 2017 at 1:50 pm

Totally flippant and backhanded comment jrs, might help to substantiate your perspective with more than emotive slurs.

disheveled . Gezz Calvinists – ????? – how about thousands of years of Anthro or Psychology vs insinuations about AET or Neoclassical

jrs , January 23, 2017 at 1:01 pm

Don't forget commute another 2 hours because you can't afford anything close by!

Ruben , January 23, 2017 at 3:27 am

OMG, where to begin:

"MMT, by contrast, stresses money's creative role in enabling productive activity and places government's limitless spending powers at the heart of this process."

" [money] is a boundless government instrument "

Limitless spending power is identical to infinite spending powers. If this is a central tenet of MMT, the whole conceptual construct can easily be disproved by reductio ad absurdum.

"And while civil society may be a site of creativity and struggle, it has limited spending abilities and will always require external support."

Sure, the support of Nature, but I guess the author is referring to Big Brother, the all-knowing and benevolent government, source and creator of all money, indispensable provider of jobs, jobs, jobs.

Before there was nothing, then came the Government and the Government said: let there be money.

Hard to take it seriously.

Furzy , January 23, 2017 at 4:19 am

I would like to see you do that via "reductio ad absurdum" because I find you absolutely clueless regarding MMT's propositions. Maybe you just like to spout off?

tony , January 23, 2017 at 6:06 am

It's a common 'argument' by people defending status quo. They claim something is ridiculous and easily disproven and then leave it at that. They avoid making argument that are specific enought to be countered, because thay know they don't actually have a leg to stand on.

fresno dan , January 23, 2017 at 8:37 am

Furzy
January 23, 2017 at 4:19 am

http://www.pragcap.com/modern-monetary-theory-mmt-critique/

skippy , January 23, 2017 at 4:55 am

So where are your – laws – from Ruben . ??????

UserFriendly , January 23, 2017 at 6:57 am

Limitless may not have been the best word. Of course the government can print money till the cows come home; but MMT recommends stopping when you approach the real resource constraint.

skippy , January 23, 2017 at 7:39 am

Taxes to mop up . but that's theft in some ideological camps .

disheveled must have printing presses down in the basement .

Ruben , January 23, 2017 at 7:58 am

Sloppy language does not help so thank you. So the next question is how do constraints (natural or other) affect spending power under MMT, is it asymptotic, is there an optimum, discontinuities?

The other major issue is that although spending power is controlled by legislatures it must be recognized that wealth creation starts with the work of people and physical capital, not by the good graces of gov't. MMT makes it sound as if money exists just because gov't wills it to exist, which is true in the sense of printing pieces of paper but not in the sense of actual economic production and wealth creation. Taxes are not the manner in which gov't removes money but it really is the cost of gov't sitting on top of the economic production by people together with physical capital.

Jamie , January 23, 2017 at 9:55 am

Help me understand your last sentence. So, if I'm a farmer, the time I spend digging the field is economic production, but the time I spend sitting at my desk planing what to plant and deciding which stump to remove next and how best to do it, and the time I spend making deals with the bank etc, these are all unproductive hours that make no contribution to my economic production?

susan the other , January 23, 2017 at 1:48 pm

Yes, Jamie. And as you point out, Ferguson is giving us a better definition of "productive". He is not saying productivity produces profits – he is saying productive work fixes things and makes them better. But some people never get past that road bump called "productivity."

JohnnyGL , January 23, 2017 at 11:16 am

"MMT makes it sound as if money exists just because gov't wills it to exist "

No, this is inaccurate, MMT says that the government must SPEND money into existence, not just issue a legal fiat. Collecting taxes in the currency creates a need for the currency. This is historically accurate and can be traced from British colonial history. They imposed taxes on the colonies in pound sterling, that compelled the colonies to find something to export to Britain in order to generate the foreign exchange to pay the taxes.

The debate is over how to get the currency in people's hands. Should the govt just cut checks and let citizens spend as they see fit? Or should the government directly employ resources to improve society where the private sector isn't interested?

Regarding user Jamie's point, I hope I can add to it by saying that someone is going to do the planning, whether it's the public sector or the private sector, planning must be done. When government does the planning, then it's decided democratically (at least in theory). If the government doesn't do the planning, then the private sector is left to do it on its own. This gets chaotic if the private sector doesn't coordinate, or can get parasitic if the private sector colludes against public interest.

Jamie , January 23, 2017 at 10:05 am

I don't think there's anything wrong with calling money a "boundless government instrument". The problem here comes from confounding a potentially infinite resource (money) with the inherently limited application of that resource. Sovereign money really is limitless, what one can do with it is not. The distinction needs to be clarified and emphasized, not glossed over.

Jim Haygood , January 23, 2017 at 12:11 pm

" money is a boundless government instrument "

Restated: " Trees grow to the sky and beyond. "

During expansions, the economy is always operating at the real resource constraint. Attempts to goose it with MMT can only destabilize it.

Mel , January 23, 2017 at 12:46 pm

"Limitless" is a pretty good word for some arguments. Look what you get with "limited": every year congress up and says, "Hey dudes, dudettes, we know you expected some governing from us, but we've decided not to do that, because we've decided that the money we've spent has taken us past the Debt Limit. So we're gonna stop now." They're jerking you around. The rules of fiat money that they're using don't work that way. In fact, Richard Nixon took the U.S. into a full fiat money system so he could keep governing without having to worry about running out of money to do it with.

PKMKII , January 23, 2017 at 9:18 am

International monetary agreements such the Eurozone's Maastricht Treaty may impose artificial limits on fiscal spending, but these are, MMT argues, political constraints. They are not economically inevitable and can immediately be dissolved.

So no, not limitless. Rather, the limitations are political ones, not economic. As long as the sovereignty of the currency is not in threat, the money supply can be increased.

vlade , January 23, 2017 at 5:28 am

The author is making some assumptions, and then goes and takes them apart. It's possilble (I didn't read the article he refers to), that the assumptions he responds to directly are made by the article, but that doesn't make them universal assumptions about UBI.

UBI is not a single exact prescription – and in the same way, JG is not a single exact prescription. The devil, in both cases, is in details. In fact, there is not reason why JG and UBI should be mutually exclusive as a number of people are trying to tell us.

and if we talk about governance – well, the super-strong governance that JG requires to function properly is my reason why I'd prefer a strong UBI to most JG.

Now and then we get a failed UBI example study – I'm not going to look at that. But the socialist regimes of late 20th century are a prime example of failed JG. Unlike most visitor or writers here, I had the "privilege" to experience them first hand, and thanks but no thanks. Under the socialist regimes you had to have a job (IIRC, the consitutions stated you had "duty" to work). But that become an instrument of control. What job you could have was pretty tightly controlled. Or, even worse, you could be refused any job, which pretty much automatically sent you to prison as "not working parasite".

I don't expect that most people who support JG have anything even remotely similar in mind, but the governance problems still stay. That is, who decides what jobs should be created? Who decides who should get what job, especially if not all jobs are equal (and I don't mean just equal pay)? Can you be firedt from your JG job if you go there just to collect your salary? (The joke in the socialist block was "the government pretends to pay us, we pretend to work"). Etc. etc.

All of the above would have to be decided by people, and if we should know something, then we should know that any system run by people will be, sooner or later, corrupted. The more complex it is, the easier it is to corrupt it.

Which is why I support (meaningfull, meaning you can actually live on it, not just barely survive) Basic Income over JG. The question for me is more whether we can actually afford a meaningful one, because getting a "bare survival one" does more damage than good.

PKMKII , January 23, 2017 at 9:27 am

That's why any JG would have to be filtered through local governments or, more ideally, non-profit community organizations, and not a centralized government. New York City's Summer Youth Employment Program offers a good model for this. Block grants of money are delivered to a wide range of community organizations, thus ensuring no one group has a monopoly, and then individual businesses, other community groups, schools, non-profits, etc., apply to the community organizations for an "employee" who works for them, but the payment actually comes from the block grant. The government serves as the deliverer of funds, and provides regulatory oversight to make sure no abuses are taking place, but does not pick and choose the jobs/employers themselves.

Praedor , January 23, 2017 at 5:42 am

I don't see it as either/or. Provide a UBI and a job guarantee. The job would pay over and above the UBI bit, if for some reason, you don't want to work or cannot, you still have your Universal BASIC Income as the floor through which you cannot fall.

Private employers will have to offer better conditions and pay to convince people getting UBI to work for them. They wouldn't be able to mistreat workers because they could simply bolt because they will not fall into poverty if they quit. The dirtbags needing workers won't be able to overpay themselves at the expense of workers because they feel completely free to leave if you are a self worshipping douche.

Dblwmy , January 23, 2017 at 11:03 am

It seems that over time the "floor through which you cannot fall" becomes just that, the floor, as the effect of a UBI becomes the universal value, well floor.

jerry , January 23, 2017 at 11:12 am

Was going to be my response as well, why such absolute yes or no thinking? The benefit of the UBI is that is recognizes that we have been increasing productivity for oh the last couple millenia for a REASON! To have more leisure time! Giving everyone the opportunity to work more and slave away isn't much of a consolation. We basically have a jobs guarantee/floor right now, its called McDonalds, and no one wants it.

Labor needs a TON of leverage, to get us back to a reasonable Scandinavian/Aussie standard of living. Much more time off, much better benefits, higher wages in general. UBI provides this, it says screw you employers unless you are willing to offer reasonable conditions we are going to stay home.

Anti-Schmoo , January 23, 2017 at 6:02 am

Why the Job Guarantee versus Universal Basic Income is not about work, BUT ABOUT GOVERNANCE!
Yep, agree 100%.
We live in a capitalist society which is dependent on a (wage) slave population.
UBI? Are you mad?
I for one am mad, give me UBI!
Time to end the insanity of U.S. capitalism

Mrs Smith , January 23, 2017 at 6:08 am

I'm curious to know if either of these systems work if there is no guarantee of "free" access to healthcare through single-payer or a national insurance? I'm only marginally informed about UBI or MMT, and haven't found adequate information regarding either as to how healthcare is addressed. It seems clear that neither could work in the US, specifically for the reason that any UBI would have to be high enough to pay insane insurance premiums, and cover catastrophic illnesses without pushing someone into bankruptcy.

Can anyone clarify, or point me in the direction of useful information on this?

financial matters , January 23, 2017 at 6:35 am

I think they're basically separate issues although MMT provides a way of thinking that federal single payer is possible.

MMT is basically anti-austerity and in favor of 'smart' deficits ie not deficits for no reason but deficits that can improve the economy and the overall social structure such as single payer, affordable education, job guarantee program.

Stephanie Kelton has commented that MMT has no real problem with a UBI if it is done in conjunction with a good job guarantee program. She is well aware of the dangers of a UBI if it eliminates most other social programs.

I think that a job guarantee at a living wage would provide a much better standard for private employment than a UBI which could just work as a supplement allowing private industry to pay lower wages. As a supplement to a job guarantee a UBI could help address issues such as payment for reproductive type work.

UserFriendly , January 23, 2017 at 7:02 am

There are different flavors of UBI, most don't mention healthcare at all. Milton Friedman's UBI flavor prefers that it replace all government spending on social welfare to reduce the government's overall burden. MMT says there is no sense in not having single payer.

Stephanie , January 23, 2017 at 7:06 am

My thought on the last thread of this nature is that if UBI were ever enacted in the U.S., healthcare access would become restricted to those with jobs (and the self-employeed with enough spare income to pay for it). You don't have to be healthy to collect a subsistence payment from to the government.

HotFlash , January 23, 2017 at 11:18 am

Here in Canada we have universal healthcare, as well as a basic income guarantee for low income families with children and seniors. There is a movement to extend that as well, details of one plan here .

In theory, I think it could be possible for the JG to build and staff hospitals and clinics on a non-profit basis or at least price-controlled basis, if so directed (*huge* question, of course - by what agency? govt? local councils?). Ditto housing, schools, infrastructure, all kinds of socially useful and pleasant stuff. However, the way the US tends to do things, I would expect instead that a BIG or a JG would, as others have pointed out, simply enable employers to pay less, and furthermore, subsidize the consumption of overpriced goods and services. IOW, a repeat of the ACA, just a pump to get more $$ to the top.

The problem is not the money, but that the Americans govern themselves so poorly. No idea what the cure could be for that.

Praedor , January 23, 2017 at 12:28 pm

Fixing worker pay is actually VERY easy. It's purely a political issue. You tie corporate taxes to worker compensation. More specifically, you set the maximum compensation for CEOs at NO MORE than (say) 50x average worker pay in their corporation (INCLUDING temps AND off-shored workers IN US DOLLARS no passing the buck to Temp Agencies or claiming that $10/day in hellhole country x is equivalent to $50k in the US. NO, it is $10/day or $3650/yr, period). At 50x, corporate taxation is at the minimum (say something like 17%). The corporation is free to pay their top exec more than 50x but doing so will increase the corporate tax to 25%. You could make it step-wise: 51-60x average worker pay = 25% corporate tax, 61-80x = 33% corporate tax, etc.

It is time to recognize that CEO pay is NOT natural or earned at stratospheric levels. THE best economic times in the US were between the 50s to early 70s when top tax rates were much higher AND the average CEO took home maybe 30x their average worker pay. We CAN go back to something like that with policy. Also, REQUIRE that labor have reps on the Board of Directors, change the rules of incorporation so it is NOT mainly focused on "maximizing profit or shareholder value". It must include returning a social good to the local communities within which corporations reside. Profits and maximizing shareholder value must be last (after also minimizing social/environmental harm). Violate the rules and you lose your corporate charter.

There is no right to be a corporation. Incorporation is a privilege that is extended by government. The Founders barred any corporate interference in politics, and if a corporation broke the law, it lost its charter and the corporate officers were directly held responsible for THEIR actions. Corporations don't do anything, people in charge of corporations make the decisions and carry out the actions so NO MORE LLCs. If you kill people due to lax environmental protections or worker safety, etc, then the corporate officers are DIRECTLY and personally responsible for it. THEY made it happen, not some ethereal "corporation".

BeliTsari , January 23, 2017 at 6:32 am

Durned hippys imagine an IRON boot stamping on a once human face – forever. OK, now everybody back to the BIG house. Massa wanna reed yew sum Bible verses. We're going to be slaves to the machines, ya big silly!

PlutoniumKun , January 23, 2017 at 7:09 am

I'm sceptical whether a guaranteed job policy would actually work in reality. There are plenty of historical precedents – for example, during the Irish potato famine because of an ideological resistence to providing direct aid, there were many 'make work' schemes. You can still see the results all along the west coast of Ireland – little harbours that nobody has ever used, massive drainage schemes for tiny amounts of land, roads to nowhere. It certainly helped many families survive, but it also meant that those incapacitated by starvation died as they couldn't work. It was no panacea.

There are numerous practical issues with make work schemes. Do you create a sort of 2-layer public service – with one level permanent jobs, the other a variety of 'temporary' jobs according to need? And if so, how do you deal with issues like:

1. The person on a make work scheme who doesn't bother turning up till 11 am and goes home at 2.

2. Regional imbalances where propering region 1 is desperately short of workers while neighbouring region 2 has thousands of surplus people sweeping streets and planting trees.

3. What effect will this have on business and artistic innovation? Countries with strong welfare systems such as Sweden also tend to have a very high number of start ups because people can quit their jobs and devote themselves to a couple of years to develop that business idea they always had, or to start a band, or try to make a name as a painter.

4. How do you manage the transition from 'make-work' to permanent jobs when the economy is on the up, but people decide they prefer working in their local area sweeping the street?

I can see just as many practical problems with a job guarantee as with universal income. Neither solution is perfect – in reality, some sort of mix would be the only way I think it could be done effectively.

Torsten , January 23, 2017 at 7:33 am

Yes. Not either/or but both/and.

To provide some context for passers-by, this seemingly too-heated debate is occurring in the context of the upcoming Podemos policy meeting in Spain, Feb 10-12.. Podemos seems to have been unaware of MMT, and has subscribed to sovereign-economy-as-household policies. Ferguson, along with elements of the modern left, has been trying to win Podemos over to MMT-based policies like a Jobs Guarantee rather than the Basic Income scheme they have heretofore adopted rather uncritically.

(Of course Spain is far from "sovereign", but that's another matter :-(

aj , January 23, 2017 at 7:48 am

1) Fire them
2) Prospering region 1 isn't "short on workers" they just all have private jobs.
3) What a good argument to also have single payer healthcare and some sort of BIG as well as the JG
4) private companies must offer a better compensation package. One of the benefits of the JG is that it essentially sets the minimum wage.

Murph , January 23, 2017 at 9:08 am

Yeah, those are pretty good answers right off the bat. (Obviously I guess for #1 they can reapply in six months or something.)

Plutonium- I feel like true progress is trading shitty problems for less shitty ones. I can't see any of the major proponents like Kelton, Wray or Mitchell ever suggesting that the JG won't come with it's own new sets of challenges. On the overly optimistic side though: you could look at that as just necessitating more meaningful JG jobs addressing those issues.

aj , January 23, 2017 at 11:17 am

I was writing that on my phone this morning. Didn't have time to go into great detail. Still, I wanted to point out that just because there will be additional complexities with a JG, doesn't mean there aren't reasonable answers.

PlutoniumKun , January 23, 2017 at 10:42 am

1. If you fire them its not a jobs guarantee. Many people have psychological/social issues which make them unsuitable for regular hours jobs. If you don't have a universal basic income, and you don't have an absolute jobs guarantee, then you condemn them and their families to poverty.

2. The area is 'short on workers' if it is relying on a surplus public employee base for doing things like keeping the streets clean and helping out in old folks homes. It is implicit in the use of government as a source of jobs of last resort that if there is no spare labour, then you will have nobody to do all the non-basic works and you will have no justification for additional infrastructure spend.

3. You miss the point. A basic income allows people time and freedom to be creative if they choose. When the Conservatives in the early 1990's in the UK restricted social welfare to under 25's, Noel Gallagher of Oasis predicted that it would destroy working class rock n roll, and leave the future only to music made by rich kids. He was proven right, which is why we have to listen to Coldplay every time we switch on the radio.

4. This ignores the reality that jobs are never spread evenly across regions. One of the biggest problems in the US labour market is that the unemployed often just can't afford to move to where the jobs are available. A guaranteed job scheme organised on local govenment basis doesn't address this, if anything it can exacerbate the problem. And the simplest and easiest way to have a minimum wage is to have a minimum wage.

aj , January 23, 2017 at 11:39 am

1) Kelton always talks about a JG being for people "willing and able to work." If you are not willing I don't really have much sympathy for you. If you are not able due to psychological factors or disability, then we can talk about how you get on welfare or the BIG/UBI. The JG can't work in a vacuum. It can't be the only social program.

2) Seems unrealistic. You are just searching to find something wrong. If there is zero public employment, that means private employment is meeting all labor demands.

3) I have no idea what you are going on about. I'm in a band. I also have a full-time job. I go see local music acts all the time. There are a few that play music and don't work because they have rich parents, but that's the minority. Most artists I know manage to make art despite working full time. I give zero shits what corporate rock is these days. If you don't like what's on the radio turn it off. There are thousands of bands you've never heard of. Go find them.

4) Again, you are just searching for What-If reasons to crap on the JG. You try to keep the jobs local. Or you figure out free transportation. There are these large vehicles called busses which can transport many people at once.

Yes these are all valid logistical problems to solve, but you present them like there are no possible solutions. I can come up with several in less than 5 minutes.

oho , January 23, 2017 at 8:04 am

For a more practical first step--how about getting rid of/slashing regressive and non-federal income tax deductible sales taxes? shifting that tax burden to where income growth has been.

Democratic Party-run states/cities are the biggest offenders when it comes to high sales taxes.

universal basic income in the West + de facto open borders won't work. just making a reasonable hypothesis.

Dita , January 23, 2017 at 8:06 am

Make-work will set you free?

voteforno6 , January 23, 2017 at 8:32 am

There might be a psychological benefit to a jobs guarantee vs. UBI. There are a lot of people that would much rather "earn" their income rather than directly receiving it.

BeliTsari , January 23, 2017 at 8:46 am

MS DLI Sharing-Economy contractor's app:

Which of these tools do you posess:
( ) Machete, pick-axe, big old hemp bag
( ) Scattergun, hound, mirrored shades
( ) Short-shorts, bandeau top, knee pads
( ) RealTree camo ACUs, FLIR scope
( ) ephedrine, pseudoephedrine, fast car

Norb , January 23, 2017 at 9:15 am

A JG would begin to rebuild the trust and cooperation needed to have a society based on justice instead of might makes right. Human life is based on obligations- we are all responsible to one another for the social system to work. The problem is always about how to deal with cheaters and shirkers. This problem is best solved by peer pressure and shaming- along with a properly functioning legal system.

I get a kick out of the "make work" argument against a JG. With planned obsolescence as the foundation of our economic system, it's just a more sophisticated way of digging holes and filling them in again. Bring on robotic automation, and the capitalist utopia is reached. Soul crushing, pointless labor can be sidelined and replaced with an unthinking and unfeeling machine in order to generate profits. The one problem is people have no money to buy the cheep products. To solve that dilemma, use the sovereign governments power to provide spending credits in the form of a UBI. Capitalism is saved from is own contradictions- the can is kicked farther down the road.

The obligations we have to one another must be defined before any system organization can take place. Right now, the elite are trying to have their cake and eat it too.

jerry , January 23, 2017 at 11:23 am

Well said!

Jamie , January 23, 2017 at 9:25 am

I agree with those who see a need for both programs. I think the critique of UBI here is a good one, that raises many valid points. But I have trouble with a portion of it. For instance:

by eliminating forced unemployment, it would eradicate systemic poverty

treats 'poverty' as an absolute when it is a relative. No matter what programs are in place, there will always be a bottom tier in our hierarchical society and those who constitute it will always be 'impoverished' compared to those in higher tiers. This is the nature of the beast. Which is why I prefer to talk about subsistence level income and degrees above subsistence. The cost of living may not be absolutely fixed over time, but it seems to me to be more meaningful and stable than the term 'poverty'. On the other hand, in a rent seeking economy, giving people an income will not lift them out of poverty because rents will simply be adjusted to meet the rise in resources. So UBI without rent control is meaningless.

Another point is that swapping forced unemployment for forced employment seems to me to avoid some core issues surrounding how society provides for all its members. Proponents of the JG are always careful to stress that no one is forced to work under the JG. They say things like, "jobs for everyone who wants one". But this fails to address the element of coercion that underlies the system. If one has no means to provide for oneself (i.e. we are no longer a frontier with boundless land that anyone can have for cheap upon which they may strike out and choose the amount of labor they contribute to procure the quality of life they prefer-if ever was such the case), then jobs for "everyone who wants one" is simply disingenuous. There is a critical "needs" versus "wants" discussion that doesn't generally come up when discussing JG. It's in there, of course, but it is postponed until the idea is accepted to the point where setting an actual wage becomes an issue. But even then, the wage set will bear on the needs versus wants of the employed, but leaves out those foolish enough to not "want" a job. Whereas, in discussing UBI, that discussion is front and center (since even before accepting the proposal people will ask, how much?, and proper reasons must be given to support a particular amount-which again brings us to discussing subsistence and degrees above it-the discussion of subsistence or better is "baked in" to the discussion about UBI in a way that it is not when discussing the JG).

PKMKII , January 23, 2017 at 9:44 am

While UBI interests me as a possible route to a non-"means of production"-based economy, the problem I see with it is that it could easily reduce the populace to living to consume. Given enough funds to provide for the basics of living, but not enough to make any gains within society, or affect change. It's growth for growth's sake, not as to serve society. Something is needed to make sure people aren't just provided for, but have the ability to shape the direction of their society and communities.

Teacup , January 23, 2017 at 9:48 am

Where I work @3/4 of the staff already receives social security and yet it is not enough seems to me human satisfaction is boundless and providing a relative minimum paper floor for everyone is just. Yet the way our market is set up, this paper floor would be gobbled back up by the rentier class anyway. So unless there is a miraculous change in our economic rent capture policies, we are screwed

So yes, just describe to people precisely what it is – a 'paper' floor not something that has firm footing yet acknowledges inequities inherent in our current currency distribution methods. And of course couple this with a jobs guarantee. I have met way too many people in my life that 'fall through the cracks' .

Portia , January 23, 2017 at 10:24 am

why is no one bemoaning the rabid over-consumption of the complainers who suck up much more than they will ever need, hoarding and complaining about people who do not have enough? the real problem is rampant out of control parasites

Teacup , January 23, 2017 at 12:04 pm

Must be a capital gains 'earner' . and a professional projectionist

Portia , January 23, 2017 at 12:19 pm

both ends see the other as a parasite

Ignacio , January 23, 2017 at 11:21 am

But Ferguson should also adknowledge that Livingston has some points.

Why on earth we politically put limits to, for instance, public earning-spending while do not put any limit to the net amount that one person can earn, spend and own?

Upward redistribution is what occurs in the neoliberal framework. UBI is distribution. Bear in mind that even in the best employment conditions, not everybody can earn a salary. 100% employment is unrealistic.

LT , January 23, 2017 at 11:58 am

The people marketing UBI and MMT have hundreds of years of attempted social engineereing to overcome. I referring to the " why people want what they want and why do they believe what they believe." Why?

The only suggestion I have is that, since everybody has a different relationship to the concept of work, the populations involved need to be smaller. Not necessarily fewer people, but more regions or nation states that are actually allowed to try their ideas without being attacked by any existing "empire" or "wanna be empire" via sanctions or militarily.
It is going to take many differerent regions, operating a variety of economic systems (not the globalized private banking extraction method pushed down every one's throat whether they like it or not) that people can gravitate in and out of freely.
People would have the choice to settle in the region that has rules and regulations that work most for their lives and belief systems (which can change over time).

Looking at it from the perspective that there can be only one system that 300 million plus people (like the USA) or the world must be under is the MAIN problem of social engineering. There needs to be space carved out for these many experiments.

schultzzz , January 23, 2017 at 12:05 pm

First, congratulations to everyone who managed to read this all the way through. IMO both this (and the guy he's responding to), seem like someone making fun of academic writing. Perhaps with the aid of a program that spits out random long words.

FWIW, when I lived in Japan, they had a HUGE, construction-based make-work program there, and it was the worst of both worlds: hard physical labor which even the laborers knew served no purpose, PLUS constant street obstruction/noise for the people in the neighborhoods of these make-work projects. Not to mention entire beautiful mountains literally concreted over in the name of 'jawbs'.

Different thought: I'm not sold on UBI either, but wouldn't it mess up the prostitution/sex trafficking game, almost as a side effect? Has anyone heard UBI fans promote it on that basis?

Ben , January 23, 2017 at 12:31 pm

The sound and fury of disagreement is drowning out what both authors agree on: guaranteed material standards of living and reduced working time. If that's the true goal, we should say so explicitly and hammer out the details of the best way to attain it.

MIB , January 23, 2017 at 1:12 pm

Interesting read society has become so corrupt at every level from personal up through municipal, regional and federal governments that it cant even identify the problem, let alone a solution

all forms of government and their corresponding programs will fail until that government is free from the monetary influences of individuals / corporations and military establishments, whether it be from donations to a political establishment or kick backs to politicians and legislators or government spending directed to buddies and cohorts

I don't pretend to understand the arguments at the level to which they are written, but at the basic level of true governance it must but open and honest, this would allow the economy to function and be evaluated, and then at that point we could offer up some ideas on how to enhance areas as needed or scale back areas that were out of control or not adding value to society as a whole

We stand at a place that has hundreds of years of built in corruption into the model, capable so far of funneling money to the top regardless of the program implemented by the left or the right sides of society

first step is to remove all corruption and influence from governance at every level until then all the toils toward improvement are pointless as no person has witnessed a "free market " in a couple hundred years, all economic policy has been slanted by influence and corruption

we can not fix it until we actually observe it working, and it will never work until it is free of bias / influence

no idea how we get there . our justice system is the first step in repairing any society

[Jan 11, 2017] Central banks did stop deflation. Which was all they really cared about. Everything else was theater.

Notable quotes:
"... "instead they've had difficulty even getting inflation high enough to hit their inflation target. Maybe the problem is the way the FED is counting dollars." ..."
"... Debt the First 5000 Years ..."
"... looks like ..."
"... "but at some point this must and will end" ..."
"... personal, anecdotal, small-sample, and otherwise qualified observations ..."
Jan 11, 2017 | www.nakedcapitalism.com
djrichard , January 10, 2017 at 12:40 pm

"instead they've had difficulty even getting inflation high enough to hit their inflation target. Maybe the problem is the way the FED is counting dollars."

Ah, but they did stop deflation. Which was all they really cared about. Everything else was theater. Bottom line, Federal Reserve is the counterparty to all the private interests naked shorting the US dollar. Which always works unless that counterfeiting process starts to go into reverse. Just like naked shorting in the stock market can go into reverse and put a big deal of hurt on the naked shorters. But with naked shorting in the stock market, the party that is doing the counterfeiting of stock doesn't have a way to prevent the play from going into reverse. In contrast, the Federal Reserve does, through QE and whatever else they can do. Believe you me, if things got bad enough, they would have done a true helicopter drop. Whatever it takes to get their "liquidity pump" working again.

And they got their liquidity pump working again and stopped deflation. (So hey they were heros, yay! /sarc) And along the way, dollars (either newly borrowed or already in the economy) ended up in assets. And those assets keep going up through more inflation. So while they may not have "levitated the economy", they did levitate the demand for their liquidity pump. (What's not to love? /sarc)

It just hasn't reached high inflation because main street isn't a player. Otherwise, if main street was a player too, like they were for the dot com bubble and housing bubble, well then look out. But everybody on main street is just trying to survive. As far as the Federal Reserve is concerned that's a perfect "wall of worry" to provide them all the cover they need to make sure inflation doesn't get out of hand. To use the words of Adam Smith, "it's a virtuous cycle". Assets go up, the plebs aren't at the party yet, so no need to take away the punch bowl.

(And hey look at all the temp jobs that main street has now. Who says the magic of the Federal Reserve isn't doing good things? /sarc)

OpenThePodBayDoorsHAL , January 10, 2017 at 1:20 pm

Ah yes, "stopping deflation", what a disaster it would be if rent, food, health care cost less. The horror: people might be able to put a little away as "savings" and maybe even "invest". Can't have that now can we.
So we have a system where the Fed controls interest rates (domestic policy) and Treasury worries about exchange rates (trade and international). Their objectives align probably 20% of the time.
Meantime "bank underwriting" is a distant memory, just sign the deal, get your bonus, if/when it goes south Papa (Momma) CB will just smash the value of the scrip some more

craazyboy , January 10, 2017 at 2:07 pm

Post 2008 they decided banks had to securitize everything and sell it, then the financial system would be stable. Your portfolio – not so much.

RobertNYC , January 10, 2017 at 1:36 pm

yes djrichard that is a nice synopsis of how this all works but where does it end? How long can it go on? It is the world's biggest Ponzi scheme and it almost ended in 2008 when the plebes could no longer take on the increasing amounts of debt to keep it going. A normal Ponzi scheme ends when it runs out of fools to fleece but this one is different because it involves central banks which can step in to keep it all going once mainstream is tapped out. That's where we are now; they ginned up massive amounts of base money that was used to prop up asset prices on behalf of the elites. This whole thing has to be the biggest fraud and crime in human history but it is so esoteric that most people can't see it. The masses get buried under inflated costs associated with the asset bubble, inflation and interest payments while a small sliver at the top lives in a rentiers paradise.

They have added massive debt to the system since the 2008 debt crisis and things are now fine? Low interest rates mask the burden but at some point this must and will end. Once they stripped the gold out of the system in 1971 they set the groundwork for an explosion of debt. It's a very scary situation.

Yves Smith Post author , January 10, 2017 at 2:16 pm

1. What you should worry about is private debt to GDP, and that is below pre-crisis levels in the US:

http://www.tradingeconomics.com/united-states/private-debt-to-gdp

However, there has been a lot of unproductive private debt issuance even so, such as companies issuing debt to buy back stock and student debt financing overpriced college costs.

This is a good explanation of why private debt, particularly unproductive household debt, is the danger:

http://www.nakedcapitalism.com/2016/09/the-private-debt-crisis.html

QE is widely misunderstood as printing money when it isn't. It's a way to lower long term interest rates and spreads (as in lower the spread of prime mortgages relative to Treasuries).

2. China continues to have a massive debt bubble. And no major economy has made the transition from being investment and export led to consumption led without having a major financial crisis.

Robert NYC , January 10, 2017 at 3:10 pm

Are you suggesting that the U.S. monetary system is healthy and sound?

Completely agree that the creation of unproductive debt is the real problem in any economy. Michael Hudson has written brilliantly on that issue. Most debt/money creation should be closely tied to productive investment.

As for private debt to GDP, I have no basis to comment on whether it higher or lower than pre-crisis levels without doing a lot of work. Those types of figures are fraught with complexity based on source data, assumptions and methodology. Would love to see those figures by sector, student loan, credit card, auto loan, mortgage, corporate, municipal, etc. In any case it is unambiguous that government debt has increased by nearly $10,000,000,000,000.00 since 2008. Does anyone think that is a good thing? And that excludes retirement and medical costs which dwarf the funded debt. Federal deficit went up by $1.4 last year, 9/30/16 year-end, after a 7 year supposed recovery when tax revenues should be peaking. What's up with that?

The U.S. may be able to borrow in its own currency but because of its current account deficit it is dependent on foreigners to play along. How long is that going to last?

Any thoughts on the 1974 deal whereby the Saudis agreed to secretly support the dollar. What happens to dollar hegemony without those kinds of deals.

https://www.bloomberg.com/news/features/2016-05-30/the-untold-story-behind-saudi-arabia-s-41-year-u-s-debt-secret

What is going on with Russia right now, why the new cold war? Russia runs a pipeline through Ukraine and is the leading supplier of natural gas to western Europe. It's not dollar based. Qatar sits on the world's largest supplies of natural gas and wants to run pipeline North through Syria. Asssad said no. U.S. then unleashed a proxy war to unseat Assad. Qatar is a U.S. client state, like Saudi Arabia, and they allowed U.S. to build massive air base outside of Doha. Qatar plays along with U.S. and in return the Al Thani family remains in power.

I am afraid this is all a bit more complicated and fragile than meets the eye.

What is your definition of printing money? Is there no such thing in your mind? Does a central bank ever print money in your view of the system other than when they ask the U.S. Treasury's Bureau of Engraving and Printing to create some federal reserve notes?

jsn , January 10, 2017 at 3:39 pm

This is a quick and informative read for 3 bucks, it addresses all your questions here:
https://www.amazon.com/Currency-Economics-Modern-Monetary-ebook/dp/B009XDGZLI/ref=sr_1_1?s=digital-text&ie=UTF8&qid=1352305630&sr=1-1&keywords=soft+currency+economics

Robert NYC , January 10, 2017 at 5:24 pm

I have read two of Randall Wray's books on MMT and Warren Mossler's Seven Deadly Innocent Frauds. I am fairly well acquainted with MMT. As for Mossler I wish he had a good editor because his stuff could read much better. As for Wray's TWINTOPT ("that which is needed to pay taxes") definition of money, you can also argue for TWINTOPP ("that which is needed to purchase petroleum") as a definition of money. Pricing the world's most important commodity in "something" is an even more effective of way of causing that something to be used as money.

As for MMT I like some of the ideas but it seems to suffer from the same fundamental problems that the current system does. If the government has a monopoly on producing money, it is a given that they will overdo it at some point just like what happens with the current private system where the banks over did it. You end up with the same rudimentary questions/problems under MMT or the current type system:

1) what are the rules governing its creation?
2) and who is in charge and gets to decide?

Either system can work if it is intelligently and honesty run but of course that is asking a lot. Unfortunately men can not be trusted to run an honest system for any length of time because creating money is the world's greatest privilege and it will always be abused at some point; war, greed, stupidity, it doesn't matter, at some point discipline is lost. That in summary is the entire history of money.

Mel , January 10, 2017 at 7:07 pm

There's a lot of history behind the MMT conception.

David Graeber, in Debt the First 5000 Years describes kings creating money in order to pay the army, and creating impersonal markets (pp. 226-227) where money was good in order to feed the army without
a) trundling huge convoys of grain all over the country all day, every day, or
b) letting the army feed itself, and stripping the country bare.

The way this had to be done without impersonal markets is described by Pierre Loti in Au Maroc (not sure where to find a version in English.) Loti was part of a French diplomatic mission to the depths of Morocco. To feed the mission, the Sultan sent word in advance to the people near each nightly stop, ordering them to provide a sufficiently larg feast. Without the modern features of civilisation, that was the only way.

One of Gandhi's early campaigns was against a move by the British governmennt in India to licence all mango trees. The situation had been that there were feral mango trees growing all over India, and anyone who was going by such a tree, and felt like a snack, could pick a mango and eat it. This scheme provided no role for the government. The plan was for each tree to be licenced, for a fee, and to destroy any un-owned, unlicenced tree. Then everybody would be obliged to pay rupees for their snacks. The government's control of society through the impersonal market would be strengthened. Pity that people would get less to eat. ISTR Gandhi won that one.

I could entertain the doubt that without pre-existing money and a global impersonal market there would even be petroleum to buy. Who would drill down to the petroleum, pump it out of the ground, and ship it halfway around the world to where you happen to be in the hope that you even exist, and, if you exist, that you even want petroleum and have something worthwhile to give in exchange? It takes a global impersonal market to aggregate personal whims and accidents into something that we call demand, and find we can count on in making far-reaching decisions on what to do. I wonder, could we even have industry without it? Hmmm

djrichard , January 10, 2017 at 7:13 pm

Check out http://www.monetary.org/lostscienceofmoney.html History shows abuse of the money supply primarily comes from two places: 1) true illegal counterfeiting by outside parties, 2) true legal counterfeiting (ahem borrowing) by inside parties who are simply shorting the currency when the economy is publicly biased towards increased private debt (think Wiemar Republic or Venezuela).

In contrast, Fed Gov fiat (MMT) is not based on a fractional reserve system. At least not the ones I hear people talk about. So the magnitude of debasement/debauchery is a lot less compared to fractional-based currencies. Plus the monetary base can always be shrunk by issuing bonds if the will power to tax is weak.

Yves Smith Post author , January 10, 2017 at 7:14 pm

MMT is not "a system". It is an empirical description of how fiat currencies work.

Saying you don't like MMT is like saying you don't like gravity.

steelhead23 , January 10, 2017 at 6:27 pm

Thanks for stepping in, Yves. But I have a minor quibble with that Private Debt to GDP graphic you linked. Because the graph's Y-origin begins at 195%, the 7.5% reduction since 2008 looks like a 500% decrease. Bottom line – private debt to GDP remains very high and the economy is much weaker than it was in 08. Unless GDP picks up quickly (less the Ponzi-esque growth in equities), our financial future does not appear strong.

Is it OK if I hope (against my better judgement) that Trump is serious about improving U.S. infrastructure through deficit spending and the loony conservatives in Congress go along?

djrichard , January 10, 2017 at 3:03 pm

"but at some point this must and will end"

If this ends, the only way it does so is through deflation. But the Fed Reserve is always on hand to do "whatever it takes" to prevent deflation.

If the Federal Reserve loses that fight (and it's hard to think of a scenario where they could ostensibly lose), then deflation would take out everybody who is in debt. Which is pretty much everybody, except people who have no debt and are holding cash. The Fed Gov would certainly have to step in to provide 3 hots and a cot.

Instead, we have an outcome where the deflation monster is kept at bay, but everybody is up to their eyeballs in debt (I'm speaking private debt here. By the way, notice how private debt forgiveness never enters into the conversation). Except for the elite, they're not in debt to their eyeballs because the height of their eyeballs can keep getting higher and higher. The elite know if the wall-of-worry disappears, forcing the Fed Reserve to raise rates, they'll be caught with their pants down. But they also know they'll be rescued again (the ol deflation monster must be defeated once again. We do this for you little people don't you know). So that's where the economy is thriving – for the elite.

Robert NYC , January 10, 2017 at 3:19 pm

In aggregate terms the elites hold the other side of all the debt that was created, that is why they won't tolerate deflation, everything implodes under such a scenario. The masses are buried under the debt, while a small minority holds the asset side of it. Therefore everything will be done to stave off deflation. System is very fragile, teetering between deflation and potential hyper inflation. They have threaded a needle so far to keep it stable but things are not normal. It will be some time before we know how this resolves itself.

craazyboy , January 10, 2017 at 1:58 pm

The issue isn't monetary policy, i.e increasing or decreasing the supply of money, the issue is that the way we've decided to do it is by increasing and decreasing interests rates. So we end up in this bazzarro world where, .
------
Stop! I know the answer!

Fed Chief Mariner Eccles explained that long ago – "pushing on a string won't work"

Keynes explains it in English – This doesn't work when in a "liquidity trap"

Our current Fed are Monetary_keynesians working in the Mariner Eccles building.

Someone tell Ben and Janet!!!!!!!!!!!!!!!!!

TosTrader , January 10, 2017 at 2:21 pm

"If we accept that only the Federal Government, through spending and taxing, can increase or decrease the supply of dollars"

the vast majority of dollars in the economy are actually created by banks in the form of deposits generated by making loans. The central bank (Federal Govt.) seeks to control the level of reserves in the interbank market and has very limited control over the the supply of money in the economy as a whole. banks do not lend reserves, which is why there can be reserves sloshing all around the system without causing inflation. As long as there are idle resources in the economy the danger of inflation is overblown.

Ranger Rick , January 10, 2017 at 11:47 am

Just follow the money. How does monetary policy influence influence the average person's finances? They don't have access to the discount window. Business investment is at an all-time low. Just witness the famously large cash hoards currently collecting dust in the Fortune 500 and companies like Uber setting billions of dollars on fire trying to get into new markets instead of developing new products. Instead they're using cheap debt to buy competitors and fire all their employees. Small businesses are disappearing and there are fewer new ones to replace them - nobody has collateral.

Until financial policy starts seriously considering "helicopter money" the economy is just going to sit there spinning its wheels, going nowhere on the backs of a vast underclass with no money to spend. Government contracts are and remain the only way the average person might even catch a glimpse of the world of finance, a fact that must seem appalling to any financial conservative.

Ivy , January 10, 2017 at 12:08 pm

Inflation is hidden in plain sight for many consumers. Just take a trip to the grocery store, or a home improvement big box, or any number of other retailers. From personal, anecdotal, small-sample, and otherwise qualified observations , retailers held prices low until the election and then started to raise them. That will add some pop to their fourth quarter earnings, while people adjust budgets accordingly.

[Jan 11, 2017] A fiat currency issuer can deficit spend without creating debt instruments

Jan 11, 2017 | www.nakedcapitalism.com
Yves Smith Post author , January 10, 2017 at 7:23 pm

This is not correct and I hate to tell you but your comments on this topic are very confused, and worse, you are terribly self confident about your erroneous beliefs.

A fiat currency issuer can deficit spend without creating debt instruments. You do not take your dollar bills in a fiat regime to the Treasury and get them redeemed for something material. The only use you can make of currency with the Treasury is to extinguish your tax liabilities.

The Fed can only 'lend' fiat. They don't 'spend' fiat, unless Congress authorizes the purchase (e.g. Tarp). But note that even foreign currency purchases of the Fed have to be cleared by Treasury (which happens behind closed doors and no one notices). So no, the Fed does not bypass Congress.

And if you mean that Fed offers deposit insurance on deposits (created via private lending) but that's still an authority given to it by Congress when FDIC was created. And the FDIC has a 'line of credit' with the Treasury, not the Fed, so again Congress is not bypassed. In fact, the credibility of the FDIC only exists because of that line of credit from the Treasury, since it means they are de facto linked to the currency issuing entity directly.

The Fed NEVER creates fiat for the private sector. It exchanges green paper money for bank reserve balances–$ for $ exchange. There is no cost to the Fed or the govt. Not to mention that the Fed's overall operations are a cash cow for the federal govt (due to its profits via interest income on securities owned vs. costs of its liabilities and salaries, etc.), so it never needs Congressional appropriations. As an MMT expert said of your BTW "This question in the first place shows that this guy has no idea how any of this works."

[Jan 11, 2017] The chart from Citibank shows the eye-popping expansion of central bank balance sheets, from roughly $3 trillion in the year 2000 to $20 trillion today.

Jan 11, 2017 | www.nakedcapitalism.com
Jim Haygood , January 10, 2017 at 12:18 pm

This chart from Citibank shows the eye-popping expansion of central bank balance sheets, from roughly $3 trillion in the year 2000 to $20 trillion today.

http://tinyurl.com/grgvnyl

Evidently the "EM" band in green is dominated by China, which accumulated over $4 trillion in forex (primarily US Treasuries) through 2013. Now it's having to sell Treasuries to prop up the yuan exchange rate.

But Haruhiko "Mad Dog" Kuroda at the Bank of Japan is picking up the slack from China with a ferocious buying binge, as Mario "Whatever It Takes" Draghi closely pursues him.

Common sense would tell you that expanding central bank assets at many multiples of economic growth is neither sustainable nor even sensible. Central banksters are giving ol' John Law a run for the money. With any luck they should be able to produce an epic calamity, since their bubble blowing is global rather than confined to one country.

jsn , January 10, 2017 at 1:22 pm

Actually, the Fed is just laundering crap from our TBTFs and supporting the purchasing power of the dollar:
http://econbrowser.com/wp-content/uploads/2015/12/fed_assets_dec_15.png
The grey is crap being invisibly written down at taxpayers expense (actually holding a very small percentage of its face value, but embarrassing for Jamie and Lloyd if admitted in public), the baby blue is keeping the imports made abroad by our multinationals "affordable" without them having to re-patriate the cash.

craazyboy , January 10, 2017 at 1:46 pm

I'm pretty sure "grey" is the "good" MBS. They swore up and down it was Fannie&Freddie MBS they were buying as part of QE – these are supposed to be the high quality end of mortgage instruments and I think it really did turn out that way.

The drek mopped up from Bears and others is called "Maiden", and is the nearly imperceptible dark blue on this chart. If they properly wrote them down immediately, then they wouldn't show up on a current chart! This is why "audit" sounds cool. Then we could have a completely different chart showing how much they did give away to their buddies.

jsn , January 10, 2017 at 3:14 pm

No doubt they did say that, I guess I've just grown less trusting.

Given the proTBTF tilt of all else that transpired I just can't believe Timmy and The Fed really took possession of anything it would have pained Jamie and Lloyd to give up.

It would be interesting to see an audit!

RobertNYC , January 10, 2017 at 1:42 pm

"Common sense would tell you that expanding central bank assets at many multiples of economic growth is neither sustainable nor even sensible. Central banksters are giving ol' John Law a run for the money. With any luck they should be able to produce an epic calamity, since their bubble blowing is global rather than confined to one country."

It's inevitable and will make John Law look like a rank amateur when this thing comes apart.

jsn , January 10, 2017 at 3:17 pm

Personally, I'm looking forward to what happened next: the Regent toured France with a detachment Dragoons collecting gold from hoarders at bayonete point!

Tom Bradford , January 10, 2017 at 4:11 pm

Yay! This article and its comments exemplifies why I spend far longer on NC than on any other site on the Web. Not only had it never before occured to me that The Wizard of Oz was an allegory of anything – tho' it's obvious even to the dim-witted like me once pointed out – it helped me understand the concepts and relationships that underlie 'money'. In short, how a pound note can be, as it says, "worth one pound".

[Jan 11, 2017] Empire of chaos: by creating military mayhem all over the world we have attracted savings to the US economy for fear it might be lost any where else.

Jan 11, 2017 | www.nakedcapitalism.com
Robert NYC , January 10, 2017 at 5:58 pm

The author's critique of modern central banking seems dead on, the fallacy of pushing on a string etc, but he seems to think their response was a mistake because what we really lack is fiscal stimulus. Pardon me if I am confused but didn't the government just engage in the biggest fiscal stimulus in the history of the world as evidenced by its massive deficit spending to the tune of ten trillion dollars. Was that not a fiscal stimulus? What is the author's point? That we need even more of this! If Mr. Ferguson would clarify that would be great.

I happen to think everything they have done is mistake and that what we need is a debt jubilee which is what William White, one of the world's foremost monetary theorists and former chief economist of the BIS also thinks.

http://www.telegraph.co.uk/finance/financetopics/davos/12108569/World-faces-wave-of-epic-debt-defaults-fears-central-bank-veteran.html

Yves Smith Post author , January 10, 2017 at 7:31 pm

No, the bailouts were not fiscal spending. They were done mainly by special facilities and those loans were paid back. QE is also not fiscal spending.

The US engaged in only about $800 billion of fiscal spending. China did the most, IIRC about $2 trillion.

William White was very good in the runup to the crisis in identifying the housing bubbles but is really clueless about the debt of fiat currency issuers v. that of non-fiat issuers, like US states and countries in the Eurozone.

RBHoughton , January 10, 2017 at 9:47 pm

There is a slight upside to the frightful monetary policy we have been obliged to pursue – by creating military mayhem all over the world we have attracted savings to the US economy for fear it might be lost any where else.

Even UK has proved unsafe and western media is making the EU look dodgy too.

So regardless of the reality of a dormant national economy the money keeps coming in.

Don't forget the tax havens either – they invest in New York.

[Jan 11, 2017] January 10, 2017 at 12:17 pm

Jan 11, 2017 | www.nakedcapitalism.com

The whole "Wizard of Oz is a parable about monetary policy" thing turned out to have been made up by a high school teacher as a device for learning about the populist movement: https://grorarebookroom.wordpress.com/2014/02/01/mythbusting-the-wizard-of-oz-parable-on-populism/

djrichard , January 10, 2017 at 1:35 pm

See http://www.halcyon.com/piglet/Populism.htm which is another refutation of the Wizard of Oz as any kind of allegory to monetary theory.

But look at the poem that's repeated in there. It's fairly clear that Frank Baum had opinions on currency. Now that particular poem is a peon to Mckinley and "honest money". Which would make one think that Baum was a hard money advocate, as McKinley and "honest money" was the counter William Jennings Bryan (WJB) arguing against the "cross of gold". But WJB's campaign for silver had the same failings as gold, they were both banker's money. Perhaps Baum saw the disadvantages either way.

In any case, Bill Still provides what I think is the better currency allegory from Frank Baum's story, in that it's an advocation against both silver (the silver shoes) and gold (the yellow brick road) and was for "paper money" issued by the Fed Gov (the emerald city). See https://www.youtube.com/watch?v=Sboh-_w43W8 . Now this is purely Bill's interpretation, just like the refutation you're linking to was admitted to be an interpretation too. I happen to think Bill's allegory works better and there's strong reason to think that this is where Baum's head was at (given he was opinionated on currency and an advocate of the farmer's vulnerabilities to issues related to currencies).

Matthew G. Saroff , January 10, 2017 at 12:18 pm

I agree with your basic assessment, but your analysis of OZ was created by high school history teacher Henry Littlefield in the 1960s as a metaphor :

Littlefield himself wrote to The New York Times letters to the editor section spelling out that his theory had no basis in fact, but that his original point was "not to label Baum, or to lessen any of his magic, but rather, as a history teacher at Mount Vernon High School, to invest turn-of-the-century America with the imagery and wonder I have always found in his stories."

Yves Smith Post author , January 10, 2017 at 2:21 pm

Wikipedia points out:

Biographers report that Baum had been a political activist in the 1890s with a special interest in the money question of gold and silver, and the illustrator Denslow was a full-time editorial cartoonist for a major daily newspaper. For the 1901 Broadway production Baum inserted explicit references to prominent political characters such as President Theodore Roosevelt .

Littlefield's knowledge of the 1890s was thin, and he made numerous errors, but since his article was published, scholars in history,[7] political science[1] and economics[11] have asserted that the images and characters used by Baum closely resemble political images that were well known in the 1890s. Quentin Taylor, for example, claimed that many of the events and characters of the book resemble the actual political personalities, events and ideas of the 1890s.[10] Dorothy-naïve, young and simple-represents the American people. She is Everyman, led astray and seeking the way back home.[10] Moreover, following the road of gold leads eventually only to the Emerald City, which may symbolize the fraudulent world of greenback paper money that only pretends to have value.[10] It is ruled by a scheming politician (the Wizard) who uses publicity devices and tricks to fool the people (and even the Good Witches) into believing he is benevolent, wise, and powerful when really he is a selfish, evil humbug. He sends Dorothy into severe danger hoping she will rid him of his enemy the Wicked Witch of the West. He is powerless and, as he admits to Dorothy, "I'm a very bad Wizard."[12]

Historian Quentin Taylor sees additional metaphors, including:

The Scarecrow as a representation of American farmers and their troubles in the late 19th century
The Tin Man representing the industrial workers, especially those of American steel industries
The Cowardly Lion as a metaphor for William Jennings Bryan

https://en.wikipedia.org/wiki/Political_interpretations_of_The_Wonderful_Wizard_of_Oz

ekstase , January 10, 2017 at 6:50 pm

There's a fascinating interview with Yip Harburg, the lyricist for "The Wizard of Oz", from Democracy Now:
http://m.democracynow.org/stories/9873

In it, there is some discussion of who Frank Baum really was. And other stuff, like how Yip's song, "Brother Can You Spare a Dime," was regarded:
"Roosevelt and the Democratic Party really wanted to tone it down and keep it off the radio,"

And why the songs stop in the film:
"on their way to the wicked witch, when all the songs stopped, because they wouldn't let them do anymore. OK? You'll notice then the chase begins, you see, in the movie.

AMY GOODMAN:

Why wouldn't they let them do anymore?

ERNIE HARBURG:

Because they didn't understand what he was doing, and they wanted a chase in there."

Art fights life, or something.

[Dec 11, 2016] TIPs and gold

www.nakedcapitalism.com

Jim Haygood December 10, 2016 at 8:47 am

Barron's investment weekly has published a "Get Ready for Dow 20,000" cover today. Is that a problem for stocks, from a contrarian point of view?

Not necessarily. Paul Macrae Montgomery, who first articulated the concept of fading the always-wrong MSM, stipulated that it's widely-circulated, general-interest publications that are the best mirrors of popular sentiment.

So far, they are largely silent on the twin asset bubbles - stocks and house prices - rising ominously beneath our feet. Looks like it's gonna be awhile before we reach the supreme silliness of Time magazine's fatuous June 2005 cover "Home $weet Home: Why We're Going Gaga Over Real Estate."

That one actually scored double points, for the MSM's presumptuous habit of invoking the cozy "we" formulation to tell readers what they think. (That's why "we" hate the MSM.)

With Time reportedly on the block, maybe a sensational "Dow 36,000" cover could goose the sale price up to five dollars instead of one. It's worth a try, lads!

Arizona Slim December 10, 2016 at 10:28 am

Summer 2005 was when Tucson's housing bubble started hissing air. After years of tight inventory, there was a proliferation of properties for sale.

Some of those properties stayed on the market for years and many of them ended up in foreclosure.

Pat December 10, 2016 at 10:57 am

Jim, odd snippet from something I heard last night struck me as being right up your alley. The guy who founded Princeton Review is now some kind of investment guru. He was talking about last years announced rate hikes, and that he told his clients they weren't going up but might reach record lows. He based that on metals traders (gold, silver etc). He says they have never been wrong about the direction of rates. (I got interrupted so if he explained the signals he was seeing from them I missed it). It should be part of a pod cast from Tim Ferriss if you want to check it out, but I really did think it was one of those things you would have in your arsenal for market prediction.

His other big advice was treat investing like a poker game, don't bet on the cards bet on the players – look for their tells. And he hasn't figured out that Uber has some real issues to deal with before its 'profits' are real, so take everything with a grain of salt.

Jim Haygood December 10, 2016 at 12:01 pm

Gold is anticorrelated to TIPS (Treasury Inflation Protected Securities) yields as shown in this chart:

https://marketrealist.imgix.net/uploads/2016/09/bondvsgold.png

TIPS didn't exist before 1997. But real Treasury yields (proxied by subtracting the trailing 12-month CPI change from nominal Treasury yields) went negative in 1974 and 1979 too, during the epic gold spikes of that era.

So this seems to be an enduring anticorrelation. However, I use the yield curve in my bond model rather than gold. The pronounced serial correlation in Fed-controlled short rates is highly non-random, signaling what the cockeyed commissars are up to.

griffen December 10, 2016 at 5:45 pm

It's DOW 40,000 or bust. I'm holding out for that Weyland-Yutani merger to be announced any week now.

[Nov 19, 2016] We should not use the term capital when referring to credit/lending that is not related to economically real outputs

Notable quotes:
"... "And even though neoliberals and international banks would have you believe otherwise, a fall in these money movements is entirely a good thing. As Ken Rogoff and Carmen Reinhart found in their study of 800 years of financial crises, high levels of international capital flows are correlated with more frequent and severe financial crises. Similarly, a 2010 Bank of International Settlements study by Claudio Borio and Petit Disyatat ascertained that cross border capital flows were over 60 times trade flows, meaning they had almost nothing to do with them. " ..."
"... I think it is apparent that the entire edifice of finance has been jiggered to benefit, Davos man and NO ONE ELSE. ..."
"... hy shouldn't Davos man want it to continue – the aftermath was set right for the 0.1% remarkably fast in the aftermath of the Great Recession – by HUGE infusions of government money, guarantees, credit, forbearance, etcetera – which for some reason can NEVER be made available to the 90% ..."
"... This is probably the most salient reason Hillary lost, but it can never, ever be proffered as a reason for it would reveal that ALL our problems are due to the rich . ..."
"... I've often wondered how "The Multiplier Effect" of money, [not] circulating and recirculating in our local economies, at the consumer level, is affected by money sent out of the country by "immigrants"? ..."
"... Is this such a small amount as not to be considered part of "cross border capital flows"? How does it affect local economies that are more important to us than what happens on Wall Street? ..."
Nov 19, 2016 | www.nakedcapitalism.com
Sound of the Suburbs November 19, 2016 at 8:27 am

You can only pillage the world once, though I think they are going for second helpings in Brazil right now.

tegnost November 19, 2016 at 11:13 am

m'kay so kind of like robbing peter (emerging markets with growth potential) to pay paul (goldman et.al.) until peter goes broke (asset bubble collapse) so paul can't be paid until he "natural" growth potential of emerging markets recovers (peters growth potential recovers from the asset bubble/debt overhang with best performance to those with more flexible currency) so that paying paul (new grifts, oops financial innovations) can be foisted on them again leading to, in hindsight only of course, and notably after paul has been paid, another collapse? rinse and repeat .is there any sense to this postulation?

JF November 19, 2016 at 11:47 am

Why do you use the term 'capital' when referring to credit/lending that is not related to economically real outputs. The rest of the article tells this story but the lead groups it all as 'capital' flows.

This is an editorial suggestion really one that does not conflate or mislead when treating credit creation used for financial asset trading as if it were the same general thing as FDI, that is, direct investment.

We have seen the financial system react to the crisis by recognizing their own unhinged behavior, and doing much less of it for good reasons. They know their credit creating behavior was nit coverting Savings into Investment, they know it was not 'capital' – so editors, let us help our writers to bring more clarity.

Grebo November 19, 2016 at 1:19 pm

I agree. We need a separate word for 'financial capital'. I am thinking 'ante' or 'stake' or some similar word from the world of gambling and confidence tricks.

fresno dan November 19, 2016 at 11:56 am

"And even though neoliberals and international banks would have you believe otherwise, a fall in these money movements is entirely a good thing. As Ken Rogoff and Carmen Reinhart found in their study of 800 years of financial crises, high levels of international capital flows are correlated with more frequent and severe financial crises. Similarly, a 2010 Bank of International Settlements study by Claudio Borio and Petit Disyatat ascertained that cross border capital flows were over 60 times trade flows, meaning they had almost nothing to do with them. "

================================================================

This is probably something that not one in 10,000 people understand (I don't really either) – but I think it is apparent that the entire edifice of finance has been jiggered to benefit, Davos man and NO ONE ELSE. And why shouldn't Davos man want it to continue – the aftermath was set right for the 0.1% remarkably fast in the aftermath of the Great Recession – by HUGE infusions of government money, guarantees, credit, forbearance, etcetera – which for some reason can NEVER be made available to the 90%

This is probably the most salient reason Hillary lost, but it can never, ever be proffered as a reason for it would reveal that ALL our problems are due to the rich .

Dave November 19, 2016 at 12:31 pm

I've often wondered how "The Multiplier Effect" of money, [not] circulating and recirculating in our local economies, at the consumer level, is affected by money sent out of the country by "immigrants"?

Is this such a small amount as not to be considered part of "cross border capital flows"? How does it affect local economies that are more important to us than what happens on Wall Street?

Three numbers hopefully to provide 'balance':

[Nov 19, 2016] Helicopter money by Stefan Gerlach

www.project-syndicate.org

Years of low interest rates and quantitative easing have not restored growth to developed countries, and many observers lately have been calling on central banks to inject stimulus into economies directly. But do the rewards of "helicopter money" outweigh the risks?

ZURICH – The world has been on pins and needles since Donald Trump's upset victory over Hillary Clinton in the United States' presidential election last week. No one – including, perhaps, the president-elect himself – quite knows what shape the next US administration will take, or what its policy priorities will be.


Compounding this uncertainty is the fact that, around the world, geopolitical tensions are rising, with developed economies continuing to experience tepid growth, even after years of record-low interest rates. For Trump to stimulate enough activity in the US economy to satisfy his zealous base, he will have to find the right balance between fiscal measures and monetary-policy tools.

Whether Trump continues the post-1945 US tradition of international leadership, or instead chooses an "America first" approach, he will not be alone in his quest for growth: Japan and eurozone countries are also struggling to bring about sustainable recoveries and meet central banks' inflation targets. Project Syndicate commentators have been at the forefront of the ongoing debate about what policymakers can do to achieve these goals. In particular, while Trump and policymakers elsewhere are embracing fiscal activism, how far they are willing or able to go remains uncertain, raising the question of what more central banks could do to stimulate demand and boost growth.

Spinning in Circles

The recent shift toward fiscal expansion reflects widespread agreement that policymakers are running out of stimulus options. Central banks can no longer rely on "forward guidance," such as half-promises that interest rates will remain low indefinitely. And quantitative easing (QE) is quickly losing its potency, perhaps because it is inherently more effective as a crisis-response mechanism than as a long-term fix.

[Nov 16, 2016] If the unsecured credit lines that make the payments system function smoothly are liquidity, then are these credit lines also money?

Notable quotes:
"... ""This analysis raises a host of questions: If the unsecured credit lines that make the payments system function smoothly are liquidity, then are these credit lines also money? Should they be money? If these credit lines that are so important to the operation of the payments system are not money, then what is the point of defining money at all? I am still puzzling over these questions so I only ask them and don't pretend to answer them here."" ..."
"... Sissoko acknowledges the role that sovereign governments play in establishing money systems but I think gives too much credit :) to private bank credit creation. ..."
"... If money grew on trees it would be worth very little (Wray 2004) ..."
"... Money is the result of the struggle between debtors' demand for money and creditors' belief that the state can service its debt, which in turn depends on tax revenues. And it is the need to work for a taxable income that gives it value. (Ingham) ..."
"... Taxes don't finance spending but are necessary for money to have state backed value. They are also an important way for the state to transfer resources whether for bank bailouts, wars, social security, health care or whatever the state deems important. ..."
Nov 16, 2016 | www.nakedcapitalism.com

financial matters November 16, 2016 at 7:50 am

Carolyn Sissoko has an interesting new paper out, Financial Stability , in which she takes on the nature of money problem.

I think her concluding paragraph is interesting

""This analysis raises a host of questions: If the unsecured credit lines that make the payments system function smoothly are liquidity, then are these credit lines also money? Should they be money? If these credit lines that are so important to the operation of the payments system are not money, then what is the point of defining money at all? I am still puzzling over these questions so I only ask them and don't pretend to answer them here.""

As a derivatives expert she takes on the interesting question of how these complex sources of credit function, they provide credit but are they really money.

I think Ingham makes a great point relevant to this, "all money is credit but not all credit is money"

Sissoko acknowledges the role that sovereign governments play in establishing money systems but I think gives too much credit :) to private bank credit creation.

If money grew on trees it would be worth very little (Wray 2004)

Money is the result of the struggle between debtors' demand for money and creditors' belief that the state can service its debt, which in turn depends on tax revenues. And it is the need to work for a taxable income that gives it value. (Ingham)

Taxes don't finance spending but are necessary for money to have state backed value. They are also an important way for the state to transfer resources whether for bank bailouts, wars, social security, health care or whatever the state deems important.

BecauseTradition November 16, 2016 at 8:55 am

If money grew on trees it would be worth very little (Wray 2004)

That would depend on the rate of growth and, assuming every citizen had an equal number and quality of such trees, be an ethical means to create fiat apart from normal deficit spending for the general welfare.

Of course there are no such trees but equal fiat distributions to all adult citizens could have the same effect.

[Oct 28, 2016] Banks sell public money as their product and they extract interest for doing so. They thus act as a transfer agent of wealth from the real economy to rentiers.

Oct 28, 2016 | economistsview.typepad.com

RGC : , October 28, 2016 at 05:42 AM

Your Money

You know that money that your bank lent you to buy your new house? Well, I want to let you in on a little secret: That wasn't the bank's money they lent you. And it wasn't some billionaire's money either. It was some of your own money, along with a little bit of mine and Tom's and Susie's and everybody else in this country. Can you imagine that?

It's a fact. It's why Henry Ford supposedly said that "if people understood our banking and monetary system, I believe there would be a revolution before tomorrow morning".(1)

When the bank lent you that money it took your promise to pay them back (a promissory note and title to the house as collateral) and in exchange it punched some numbers into a computer, creating your deposit account and thereby creating the money it lent to you.(2)

But how can that be, you say. How can the bank just invent money like that? Well they do "just invent money" and they can do it because our government agrees with them that they can do it.

But don't they have to pay for that money, you say. No, they don't. But they do have to be a depository institution ( a place you can keep your money on deposit) and there is some expense for them to that.

But they are charging me interest on that money, you say. Yes indeed, they are charging you interest on your own money, and mine, and Tom's, and Susie's, etc.

But that bank is a private business, and banks make a lot of profit, why should we pay them to loan us our own money, you say. Good question.

(1)
http://www.brainyquote.com/quotes/authors/h/henry_ford_3.html
(2) http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf

pgl -> RGC... , October 28, 2016 at 05:58 AM
"But don't they have to pay for that money, you say. No, they don't. But they do have to be a depository institution ( a place you can keep your money on deposit) and there is some expense for them to that."

Again? Take a look at the income statement of any bank. There is interest expense for them on those deposits. OK, it is low but then there are those subsidized services which is why noninterest expenses exceed noninterest income. Again - no exactly a total expense of 5% but mortgage rates today are not exactly 6% either.

RGC -> pgl... , October 28, 2016 at 06:23 AM
I said they incur some expenses.
pgl -> RGC... , October 28, 2016 at 07:18 AM
We all do. But I see you waste no time doing actual financial economics. If you did, you might realize how to capture monopoly profits. Look at the average return to equity compared to what you'd predict from a CAPM model. When I do this for health insurance companies, their average return is 3 times what they would be from a competitive market. When I do this for major banks, the average return to equity = the CAPM prediction. Estimated monopoly profits = 0.

Of course you have no idea what any of this means as all you know is word salad.

RGC -> pgl... , October 28, 2016 at 07:29 AM
Should health insurance companies exist?

Banks sell public money as their product and they extract interest for doing so. They thus act as a transfer agent of wealth from the real economy to rentiers.

pgl -> RGC... , October 28, 2016 at 05:59 AM
"banks make a lot of profit".

The return to equity for banks is about what one would expect from a risk-adjusted return perspective. Oh yes - the Capital Asset Pricing Model properly applied would show what utter nonsense this is.

RGC -> pgl... , October 28, 2016 at 06:27 AM
Jamie Dimon makes a bundle in comp, which reduces profit. Bankers are highly compensated for lending us our own money.

You defending banks now?

RGC -> RGC... , October 28, 2016 at 06:32 AM
Plus banks' access to public money means they get to blow up the economy periodically.
pgl -> RGC... , October 28, 2016 at 06:47 AM
Banks will always exist. Of course proper regulation of financial institutions can address this problem. But your word salad has nothing to do with the real issues.
pgl -> RGC... , October 28, 2016 at 06:46 AM
He does but what is the percentage of JPM's total assets? Do you even know? You might need a microscope to see it. And no - I am not defending banks. But your word salad is not getting at the real issues. And yet you persist.
RGC -> pgl... , October 28, 2016 at 06:50 AM
And you are not refuting anything I said. What are the real issues?
pgl -> RGC... , October 28, 2016 at 07:19 AM
Yea I have. Which is pretty amazing since you have said nothing of substance.

What are the real issues? Do you even read the various posts our host puts up? Or do you just babble BS 24/7?

RGC -> pgl... , October 28, 2016 at 07:41 AM
What did you refute, specifically?
RGC -> pgl... , October 28, 2016 at 06:47 AM
But the product they are selling is your own money, and mine. They are basically legalized counterfeiters.
pgl -> RGC... , October 28, 2016 at 06:47 AM
You must love word salads.
anne -> pgl... , October 28, 2016 at 06:47 AM
https://en.wikipedia.org/wiki/Capital_asset_pricing_model

In finance, the capital asset pricing model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio.

pgl -> anne... , October 28, 2016 at 07:23 AM
Let's do this for a bank. Expected return to assets = risk-free rate (1%) plus a 1% premium for bearing operational risk. But then the equity to asset ratio for banks is only 10% so the expected return to equity includes a 10% premium for bearing both operational risk and leverage risk. As such, the expected return to equity = 11% for these highly levered firms. And on average that is their actual return to equity.

For a great application of these thoughts - see that paper by Sarin and Summers. You may not remember when I put it up weeks ago but my internet stalker put up a link to it just yesterday. Of course this was PeterK's childish way of attacking someone who actually contributes to this blog. I said he should read it. So should RGC. They might learn something.

JohnH -> pgl... , October 28, 2016 at 07:56 AM
LOL! pgl assumes that banks' investors have a god-given right to a risk premium of 10%.

Of course, risk premiums are more in the range 4-5%, far below pgl's banker-coddling assumption.

"Some economists argue that, although certain markets in certain time periods may display a considerable equity risk premium, it is not in fact a generalizable concept. They argue that too much focus on specific cases – e.g. the U.S. stock market in the last century – has made a statistical peculiarity seem like an economic law."
http://www.investopedia.com/terms/e/equityriskpremium.asp#ixzz4OOLOzdqg

As for the economic concept of the time value of money, whereby savers get rewarded for setting money aside...the longer the time, the greater the reward, well, central banks have pretty well destroyed that with negative interest rates.

Time value of money: RIP. Nonetheless investors are still supposed to reap their extravagant risk premiums!!!

Fred C. Dobbs -> RGC... , October 28, 2016 at 06:30 AM
It's a Wonderful Life movie clip:
Bailey vs Potter - Democrat vs Republi... https://youtu.be/n2G0n3035Ns via @YouTube

(from about 1:30)

It's A Wonderful Life Bank Run https://youtu.be/iPkJH6BT7dM via @YouTube

(from about 1:00)

See also: the Mae sisters, Fannie & Ginnie

https://en.wikipedia.org/wiki/Fannie_Mae

https://en.wikipedia.org/wiki/Government_National_Mortgage_Association


EMichael -> Fred C. Dobbs... , October 28, 2016 at 07:44 AM
Fred,


the "wonderful Life" thing is a perfect example for this topic.

kudos

EMichael -> RGC... , October 28, 2016 at 06:42 AM
The stupidity never stops.

Fantasy land bs.

Damn.

pgl -> EMichael... , October 28, 2016 at 06:48 AM
Notice when I tried to introduce some real economics to the discussion - he changed the subject.
EMichael -> pgl... , October 28, 2016 at 07:16 AM
He can't figure out this aggregator thing. He cannot figure out the investor thing. He certainly has no knowledge of the secondary market.

He takes tiny little pieces of things, ignores the rest and then comes to a conclusion. Of course the conclusion is that MMT makes sense. Everyone knows it doesn't make sense and cannot work world.

Which is why he stays in his own world.

EMichael -> EMichael... , October 28, 2016 at 07:16 AM
oops

"cannot work in the real world"

pgl -> EMichael... , October 28, 2016 at 07:24 AM
He ignores basic finance. But then so does PeterK as actual thinking just gets him all angry. Which means you and I are tagged "liar". This is the intellectual garbage that is ruining this place.
RGC -> EMichael... , -1
"Money creation in practice differs from some popular misconceptions - banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they 'multiply up' central bank money to create new loans and deposits."

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf

[Oct 23, 2016] Why money should not be considered to be a fuel for economics

Notable quotes:
"... I'm increasingly interested in the metaphors around banking, which seem to still come out of early 19th c invention of engines, all of which used ' fuel ' as a central tenet: 'the money supply fuels the economy'. Economics seems drenched in outdated, antiquated metaphors where ' fuel ' is always and everywhere a good thing, with no polluting externalities, and no downside costs. ..."
"... Fuels don't lie, cheat, or steal - continuing to use fuel as a central metaphor enables banks, economists, and central bankers to put their fingers in their ears and howl "La! La! La! Using metaphors shaped by sail-powered whaling ships hunting for blubber is working just great for us!!" After all, calculus had been invented by the 1820s - so math + moneyAsEngineSpeak = economics. ..."
"... If money were more widely regarded as a social tool: recognized as a tool that requires communication, social networks, and flourishes within civil society, then Haldane's observations would be met with "Doh, you betcha!" ..."
"... Then, also, Bill Black's observations that crime actually does exist, and often looks exceptionally respectable, would be impossible to ignore. ..."
"... I interpreted Brexit as a 'tea leaf' that the banks could no longer be made fine-proof without triggering social unrest. ..."
"... The way that I read this, contemporary economics and finance leads to utter, unmanageable disaster from which there is absolutely no way out. The engine 'melts down', so to speak. I feel as if I have spent the past 8 years watching systems nearly implode, be saved by extraordinary (lunatic) measures, and in the end the systems of thinking that created these problems are precisely the mental pathways that keep people stuck in a labyrinth of dysfunction. ..."
"... It's hard to work out how "1. Implode, not too violently" could give rise to anything other than lethal shortages, especially in urban environments, and how this could lead to anything but "2. blow up, social unrest" anyway. ..."
"... Money is social relations, power relations, if Gold is law then the powerful will grab the gold. If not, they'll grab the money creating buttons in various spreadsheets, unless opposed by all. ..."
"... Maybe there is a way to make the vulnerability that the central banks and banksters and CorpoStates like GE and Cigna and Goldman Sux nd the rest impose on the vast rest of us into a mutual exposure? ..."
"... There is nothing wrong with interest, as long as the rate is reasonable. It is a service charge for someone handing you money now to buy what you want now instead of waiting to save up the money. Interest does not make an economic system unstable. It's the same as a massage or other service you buy. You just need enough income to cover it, and the principal payment of course. ..."
"... "As noted in the article [money is] a concept created by human beings and should be considered a very malleable tool that we can use to do pretty much whatever we as a society decide we want to with it. If we truly wanted to create a more equitable society there is nothing stopping us from doing so except the greed of the few." ..."
"... The Big Lie that the federal government needs tax revenue in order to operate, so we "can't afford" the social benefits that help the non-rich, must be constantly debunked and rejected. ..."
"... The terminology of finance is designed to hide predatory and extractive activities behind a curtain of beneficial-sounding words. These terms are deeply embedded, and serve both to put some friendly makeup on the business, and allow the "consumers" to feel better about their capitulation. The process is akin to the way politicians wrap themselves in the flag while they sell out the citizenry. We know deep down that they are lying, but we prefer the false patriotism because it serves the lies we prefer to tell ourselves. We bitch and moan, but we play our part, because not doing so leads to trouble. It is the way most of us live our lives. ..."
"... Most people go along the big lie because of hope. ..."
"... Money is nutrition, not a snack. It's food and fertilizer. It makes things grow. You have to share it with other life like bacteria and worms: without these organisms in your gut ecology, you get sick (autism, diabetes, obesity, M.S.). Idiots try to convince us these organisms are parasites instead of symbionts just like Monsanto thinks bees are disposable or Donald Trump likes to think of pregnant women as drags on business profits. ..."
"... If you think altruism is for suckers, your Ayn Rand economy collapses because you confuse parasites with symbionts and symbionts with parasites. You can't distinguish between compensation for earned and unearned income. What's a tax and what's theft? Try living without bacteria making butyrate in your gut. Wells Fargo can no more survive without little people like airport janitors to scrub out the TB and Ebola stains than our cells can breathe without mitochondria. Yet who gets their pay driven down in corporate America? ..."
Oct 22, 2016 | www.nakedcapitalism.com
... ... ...

ReaderOfTeaLeaves made an important observation yesterday on a post by Bill Black , i n reply to a comment by another NC regular and sometimes guest blogger, Clive . It describes a set of seductively inaccurate metaphors used to depict banking, money, and finance. Needless to say, some of the recent coinages, like "sharing economy" are downright Orwellian yet taking hold, but the older ones, by being well worn tropes, are so routine that the implicit messaging gets nary a thought.

By ReaderOfTeaLeaves

Clive, FWIW, I'm increasingly interested in the metaphors around banking, which seem to still come out of early 19th c invention of engines, all of which used ' fuel ' as a central tenet: 'the money supply fuels the economy'. Economics seems drenched in outdated, antiquated metaphors where ' fuel ' is always and everywhere a good thing, with no polluting externalities, and no downside costs.

Hence, what matters is 'efficiency': it's moneyAsEngineSpeak, so to speak.

Lordy, it's all petrochemical: from a time when chemical and mechanical engineering (and physics) were in their relative infancies and whaling schooners were sailing out of Nantucket.

Fuels don't lie, cheat, or steal - continuing to use fuel as a central metaphor enables banks, economists, and central bankers to put their fingers in their ears and howl "La! La! La! Using metaphors shaped by sail-powered whaling ships hunting for blubber is working just great for us!!" After all, calculus had been invented by the 1820s - so math + moneyAsEngineSpeak = economics.

Egads.

In that paradigm, Bill Black is a mere scold, an oddball, a scruffy prophet in the wastelands, so to speak.

If money were more widely regarded as a social tool: recognized as a tool that requires communication, social networks, and flourishes within civil society, then Haldane's observations would be met with "Doh, you betcha!"

Then, also, Bill Black's observations that crime actually does exist, and often looks exceptionally respectable, would be impossible to ignore.

Timmy Geithner is probably not a fan of: (a) Bill Black or (b) the idea of money as inherently social. Fuel is an emotionally sterile construct to work within; it enables one to avoid moral qualms, or any sense of personal responsibility when ' engines blow up', or when they 'run out of fuel '.

The fact that Haldane's observations and analysis are not more widely embraced suggests that somehow the business schools, economics departments, and bankers all still use thought processes shaped in the era of whalers seeking blubber for lanterns and lamps. Also, they probably still receive endowments from the Kochs, Exxon, and other fuel obsessed interests.
Egads.

Until the metaphors move to biology, with a concomitant recognition that some kinds of ' fuel ' (aka Coke, Fritos, Doritos, donuts) work for short-term energy bursts, but carry extremely negative longer term costs, I doubt that even the best attempts to muddle through will get us out of this mess. Without amendment, this system is going to do one of two things: (1) implode (not too violently) or else (2) blow up (social unrest).

I have no idea what the banker equivalent of 'chard, lettuce, and celery' would be, but some bright mind ought to be thinking about it. (You distinguish yourself as such a mind; I hope that my metaphor is not too offensive…)

I interpreted Brexit as a 'tea leaf' that the banks could no longer be made fine-proof without triggering social unrest. Then I read your comment, esp:

the U.K. government is stuck with its vast holding in RBS. The only way it could ever be rid of the RBS albatross is for RBS to have some vague hope of (eventually) earning its way back to being something other than a complete basket case.

Apart from, ironically, the central banks' own ZIRP policy, the biggest threat to this is endless redress for wrongdoing.

The way that I read this, contemporary economics and finance leads to utter, unmanageable disaster from which there is absolutely no way out. The engine 'melts down', so to speak. I feel as if I have spent the past 8 years watching systems nearly implode, be saved by extraordinary (lunatic) measures, and in the end the systems of thinking that created these problems are precisely the mental pathways that keep people stuck in a labyrinth of dysfunction.

Banking needs to be completely rethought, using the social sciences, which include the realities of criminal conduct corroding the system to such a degree that it is threatening to implode. I'm moving toward being agnostic as to whether this is a good thing, or not. Either way, the present systems as I've read you describe them do not seem even remotely sustainable.

John Merryman October 22, 2016 at 7:21 am

The metaphor I think applies is that we use money as both medium of exchange and store of value. While the first is inherently dynamic, the second is static, so a good analogy is that in the body, the medium is blood, while the store is fat. The trick has been how to store extreme amounts of notional wealth and that is largely by having the government borrow it back out and spend in ways which support the private sector, but don't compete with it in the hunt for profits. So are all those pallets of money going to fund our wars really about war, or is it about keeping that money flowing in one end and out the other? Consider all those super secure US savings bonds are mostly just being poured down various rat holes, rather then building a sustainable society.

This probably goes back to Roosevelt, who borrowed a lot of unemployed capital to put a lot of unemployed workers back to work.

Money is not a commodity to be mined or manufactured, whether gold or bitcoin, but a contract. Every asset is the other side of an obligation. It allows a large economy to function, but it also reduces community reciprocity, creating atomized societies.

Like blood, the economy needs very regulated amounts of money, as it functions as a voucher system and storing lots of excess vouchers eventually causes the system to collapse, when everyone tries to dump them at once. If government threatened to tax excess out, people would have to find other ways to store value, like in stronger communities and healthier environments, aka the commons. Most people save for the same general reasons, housing, healthcare, retirement, etc, which are ultimately community functions anyway.

Finance as a public utility doesn't have to be subservient to government. Much as government is analogous to the central nervous system, finance is to the circulatory system and the head and heart are separate organs.

Government started out as a private business, institutionalized as monarchy, before becoming a public utility. Now is the time to do the same with finance.

Never let a good crisis go to waste.

Edward Morbius October 22, 2016 at 8:54 pm

I'm leaning strongly to the idea that money is information . More specifically, it's information about general claims on national commerce. That gold coin in your hand is a bidding right . The obligation isn't to any one person, but your possession of it means that there's one less gold coin's bidding power throughout the rest of the economy.

I'm still sorting out my thoughts on this, but Frederick Soddy, the Technocrats (a short-lived 1920s – 1930s US movement), and the ecological economists (Georgescu-Roegen, Daly, Boulding, etc.) seem to make more sense to me.

The more I read of traditional / classical / neoclassical / post-Keynesian monetary theory the more I suspect nobody has much of a clue.

PuzzleMonkey October 22, 2016 at 7:30 am

Excellent and original points that make a tremendous amount of sense. Thank you.

One tiny quibble. It's hard to work out how "1. Implode, not too violently" could give rise to anything other than lethal shortages, especially in urban environments, and how this could lead to anything but "2. blow up, social unrest" anyway.

scott 2 October 22, 2016 at 8:13 am

US Grant rode in a horse-drawn carriage from his inauguration to a White House lit with coal-gas, while oil or candles. Medicine, sanitation, and agriculture was hardly different than it was in Roman times. The railroad and the telegraph represented technological progress.

A little more than 30 years later McKinley rode in an automobile to a White House lit with electric lamps, that had running water and sewage. Steel framed buildings could rise more the 3-4 stories off the ground. The causes of many diseases were known and somewhat preventable. The first radio transmission was months away, and the first powered flight was 3 years away. The standard of living of an average American doubled during that period. And it was all done under the gold standard.

DGP per capita of the US peaked in 1973, the same time Bretton Woods formally ended. A dollar today buys what 3 cents could buy when the Fed was formed. Do these FACTS escape the Krugmans of the world or are they merely inconvenient and in conflict with what seems to be the true nature of academic economics, to provide pseudo-science cover to political policy?

BecauseTradition October 22, 2016 at 9:14 am

By all means let's go back to worshipping a dumb, shiny metal rather than, for instance, removing all priviledges for the banks. And let's replace theft by inflation and deflation with theft by deflation alone.

And let's confuse correlation with cause since the massive gold and silver strikes during that period greatly increased the money supply and indeed, in some places, caused huge price inflation. And let's forget that it is the government's authority to tax that gives value to fiat and give gold owners a huge bonanza by making fiat needlessly expensive.

Tinky October 22, 2016 at 9:28 am

Setting aside your implied straw man, that it's a binary choice between unconstrained credit creation, and "worshipping" gold, would you argue that today's society is better or worse than that of 1970, just before the final (golden) constraint was broken?

Pespi October 22, 2016 at 10:36 am

Does the answer to this question answer the question? Money is social relations, power relations, if Gold is law then the powerful will grab the gold. If not, they'll grab the money creating buttons in various spreadsheets, unless opposed by all.

craazyboy October 22, 2016 at 1:54 pm

Or both. Hitler thought Chartalism (grandfather to MMT) was a great idea, then invaded France and stole France's sizeable gold horde too! These greedy people want it all!

BecauseTradition October 22, 2016 at 11:48 am

just before the final (golden) constraint was broken? Tinky

The central bank should not be allowed to create fiat for the private sector (e.g. Open Market Purchases) AT ALL so no constraint is needed there other than absolute prohibition.

As for the monetary sovereign, price inflation is a restraint wrt fiat creation since the voters hate it.

Also, please note that the demand for fiat is greatly reduced via other privileges for the banks. Eliminate those and the demand for fiat shall greatly increase – greatly increasing the amount of new fiat that can created without significant price inflation. This will be especially the case when government provided deposit insurance is properly abolished since a huge amount of new fiat should be required*.

*For the xfer of at least some currently insured deposits to inherently risk-free accounts at a Postal Checking Service or equivalent.

Tinky October 22, 2016 at 12:38 pm

Sounds good in theory, but how do you imagine that we might get to the point at which central banks are prohibited from creating credit for the private sector?

JTMcPhee October 22, 2016 at 12:55 pm

How much of that fiat creation gets done via electronic means? Maybe there is a way to make the vulnerability that the central banks and banksters and CorpoStates like GE and Cigna and Goldman Sux nd the rest impose on the vast rest of us into a mutual exposure?

I mean, "they" can leverage and disappear and derivatize "capital" and ZIRP and NIRP with impunity, and steal people's homes and garnish and change contract terms on personal accounts unilaterally.

Is there a turnabout, or are "we" so terrified of "instability" (where no "stability" really exists, "disruption " and all that, not to act? As well demonstrated in many posts in this very blog, it's not like the Fortress of FIRE's walls are any stronger than the foundations it is "coded" on…

John Zelnicker October 22, 2016 at 9:49 am

@scott 2 – "A dollar today buys what 3 cents could buy when the Fed was formed."

That something is true does not make it relevant; it can also be misleading. The real (domestic) purchasing power of a dollar is determined by the amount of labor it takes to earn that dollar. With the gains in labor productivity since 1913, it takes much less labor to earn today's dollar than it took to earn that 3 cents 103 years ago. Comparing the nominal cost of a loaf of bread in 1913 with its nominal cost today tells us nothing useful.

BecauseTradition October 22, 2016 at 10:08 am

Adding that deflation rewards risk-free money hoarding – a self-defeating strategy since progress requires taking risks.

OpenThePodBayDoorsHAL October 22, 2016 at 6:52 pm

Yes isn't it awful when the prices of goods and services go down, I hate it when I have to spend less money to eat and obtain shelter and all of the other necessaries of life.

https://mises.org/library/deflating-deflation-myth

Agricultural productivity rises so food costs less; industrial productivity rises so goods cost less; and these are what is known as "progress". Increasing productivity is what raises our standard of living.

But ah, there's a fly in the ointment, we have a debt-based money creation system. Problem

1.): Banks can print the principal but they can't print the interest. This leads to Problem

2.): people borrow either because they think they can grow money faster than the debt service, or because they are desperate and have no other choice.

Problem 2 (a) is that debt pulls demand from the future to the present, and when enough demand is pulled forward people will no longer feel they should borrow for future growth because there is none in sight. This leaves only desperate people borrowing to service existing outstanding debt and that prophecy fulfills itself.

We are told this is somehow a "steady state" system but that is mathematically and obviously incorrect. Even with unnatural acts like interest rates below zero (how can time preference be below zero, and what does that say for the prospects for growth?) the system winds down and needs to be completely reset.

The percentage of times that debt-based currency systems have failed in the past and gone to zero = 100…leave it to alchemists economists to insist they can pull it off though.

OpenThePodBayDoorsHAL October 22, 2016 at 7:09 pm

Like the Soviet Union we now live in an era of centrally-planned price fixing for the most important price of all in the economy: the price of money.
It's true that in eras where the price of money fluctuated wildly there were also wild fluctutaions in the economy, booms and busts.

But someone made the statement: "The Fed makes the economy more stable. But I do not think that word means what you think it does".

So no more busts…and no more booms, either. So put the periods of fastest economic growth and fastest rises in the standard of living out of your mind, those are history. And given the mathematics of "unlimited" debt creation, we'll get the bust anyway.

craazyboy October 22, 2016 at 7:19 pm

There is nothing wrong with interest, as long as the rate is reasonable. It is a service charge for someone handing you money now to buy what you want now instead of waiting to save up the money. Interest does not make an economic system unstable. It's the same as a massage or other service you buy. You just need enough income to cover it, and the principal payment of course.

Some people seem to have this idea that x amount of money was created to buy a car, but none was made to pay the interest. This causes the world to end. Not so. Money circulates and we know that around a trillion or so in circulation seems to be enough to support our $18 T in annual GDP. What is does mean is to pay off the 5 year car loan, you spent 4 years paying off the car and another year paying the interest.

A benefit of interest is it may allow people to live past retirement age – but there there is little economic focus on this phenomena.

Vatch October 22, 2016 at 8:15 pm

There is nothing wrong with interest, as long as the rate is reasonable.

In principle this is true, but it leads to a paradox in an economy in which money is based on debt. You start your second paragraph with an acknowledgement of this, but then you back down. In such an economy, money is created when it is loaned - this money is the principal of the loan. When the money is paid back, the money disappears.

But wait - the debtor must also pay back more than the principal of the loan; he or she must also pay back the interest. How is the interest created? The same way as the principal, but it is created by someone else's loan. So in a debt based economy, the amount of money in existence is less than the total amount of people's debts.

If everyone is thrifty, and pays back their loans promptly, some people will never be able to get the money to pay their interest. It's a game of musical chairs.

craazyboy October 22, 2016 at 8:51 pm

Pretty close, but consider this. The loan got paid back, the "money" disappeared, but the bank gained it as new loan capacity. The bank makes a new loan. So far I think I'm repeating what you stated. One minor problem is you say money is less than debt – it will be – debt is the contract for the entire amount. But not everyone pays it all off at once – we just need the liquidity to be there so the payor's personal bank account, or the one of their employer, doesn't run dry.

So at this point it's a matter of the banking system and the Fed managing liquidity. But the size of the Fed balance sheet and reserves steadily increases over the years to account for growth and any other liquidity needs the banks may have. It's either done directly with banks – buying treasury bond assets or loans to banks, or they buy Treasuries in the market, the money goes somewhere, then there is interbank lending to make it go where it's needed. (all in theory, of course. But the theory seems sound, when uncorrupted.)

OpenThePodBayDoorsHAL October 22, 2016 at 10:06 pm

You make it sound like a steady state system, but it's not, debt is *always* issued in excess of people's capacity to pay whether for political, psychological, or other reasons. The Fed knows this. So they desperately want to reduce the total indebtedness by inflating it away, and this puts everyone on a giant rat race treadmill, working two jobs trying to outrun the rise in prices. Given the rise in productivity we're all supposed to be living like the Jetsons by now but Oh No gatta keep running to stay in one place.
The Fed has forgotten that there is another way to reduce serial overindebtedness and that is B-A-N-K-R-U-P-T-C-Y. It has the added advantage of being an actual capitalistic endeavor, and not the inverted hyper-socialism we have today.The Fed keeps putting out brush fires so the dead wood keeps building up, eventually there is an unholy crowning conflagration that takes the whole forest with it.

craazyboy October 22, 2016 at 10:24 pm

Firstly, I said there is nothing wrong with interest . If you want to shift to "could something go wrong with principal_plus_interest in a fractional reserve central banking system", then, why yes! Plenty!

No, the system is by no means steady state – the economy has ups and downs and there are those occasional "credit crunch" periods where banks get spooked over some such thing and stop lending completely and then it seems like all the money disappeared. But that's why we have the Fed and everyone furiously managing liquidity.

Sluggeaux October 22, 2016 at 2:12 pm

Since we're on a terminology thread (and my grandfather was a whaler), the whaling vessels out of Nantucket tended to be square-rigged - barques, brigs, etc. Schooners were coastal vessels used by fishermen more often than by whalers, who travelled long distances to launch their hunts.

Great post - I want to puke every time I hear Wall Street referred to as an "economic engine." More like "social engineering" - of fraud schemes.

uncle tungsten October 22, 2016 at 10:07 pm

Ah! a new term is coined (pun intended):- fraudgineering always included in any sentence where the words "Wall Street" or a named bank is used.

Moneta October 22, 2016 at 8:32 am

A couple of generations ago most people lived on farms. Many would trade grain to pay the miller. In essence, hard cash was needed for goods at the general store.

Debt was used to finance big projects that were based on hard assets, land, commodities.

Fast forward to today…. banks still favour collateral based on hard assets yet services are a much bigger part of our economy. I would venture to say that banks lend on soft collateral when it is fed by sectors that have hard asset collateral or with a government guarantee.

IMO, get government out of everything and watch the economy drop to an economy of sustenance based on hard asset collateral which will get increasingly constrained with world population going from 7 to 9B. Exactly what rentiers LOVE!

Moneta October 22, 2016 at 8:38 am

Services are a bigger measured part of our economy. Family members on farms would do all kinds of work or services but these were not recorded.

scott 2 October 22, 2016 at 8:57 am

Debt was used to finance increases in productivity. Unless you have a sweat shop in your basement, a house is not a productive asset. It's a slowly appreciating consumer of capital, real and financial (utilities, maintainance, and taxes). In distorted markets like California, it can make a lucky few a lot of money while turning the area into a feudal system of land owners and serfs.

A side effect of financialization has been to turn the US economy into one that lives, temporarily, on housing speculation. When people realize that spending $2 million on a bungalow that should only cost $40K is the TRUE mis-allocation of capital, let's hope they don't realize that all at once.

lyman alpha blob October 22, 2016 at 10:06 am

A couple generations ago land in many places was still relatively cheap. Asked my father once how our family of dairy farmers managed to have as much land as we do and was told that my grandfather often received land as payment. He'd give someone an animal or a side of beef and they'd give him an acre they owned abutting his property that they weren't using for anything anyway. I've seen some of the old ledgers found in his attic and as you noted, cash was not just in essence but in fact used for goods at the general store. The barn itself was built with the help of the community although I'm not sure how that was paid for but I'd wager that any financing was minimal.

The economy was a few steps above just sustenance but the population was a lot less and there weren't nearly as many rich people from the city coming in looking for second (or 3rd or 4th) homes in the country driving up the cost of real estate. Two generations later land is much more dear to the point where our family likely wouldn't be able to afford to purchase property if they needed extra acreage.

There are far too many economists who seem to think that money actually does grow on trees in the sense that it's a naturally occurring resource that human beings can't control – it's all determined by markets. In that sense I'd describe money not so much as a fuel but as a weapon. I believe Jon Perkins had a similar description in his Confessions of an Economic Hitman. Weaponized war is no longer the first option among advanced economies – first they'll try to bleed other countries dry with economics. It's only when the victims won't cave that the bombs start dropping now.

But money does not occur naturally and it should not be considered a fuel or a weapon. As noted in the article it's a concept created by human beings and should be considered a very malleable tool that we can use to do pretty much whatever we as a society decide we want to with it. If we truly wanted to create a more equitable society there is nothing stopping us from doing so except the greed of the few.

John Zelnicker October 22, 2016 at 12:22 pm

@lyman alpha bob – "As noted in the article [money is] a concept created by human beings and should be considered a very malleable tool that we can use to do pretty much whatever we as a society decide we want to with it. If we truly wanted to create a more equitable society there is nothing stopping us from doing so except the greed of the few."

Adding: The Big Lie that the federal government needs tax revenue in order to operate, so we "can't afford" the social benefits that help the non-rich, must be constantly debunked and rejected.

TheCatSaid October 22, 2016 at 2:05 pm

Weaponizing money. That's a valuable concept. It reminds me of the end of David E. Martin's (true-story-called-fiction-to-avoid-lawsuits) book "The Apostles of Power". And this was the reason he wrote the book, actually–to fend off a major play to steal all the electronically-stored reserves of the Fed into their own accounts, and destroy the evidence of their actions by triggering a nuclear explosion of the precise nuclear power station that provided the power to the NYC/NJ computers that stored the data. By telling enough about the plan in process (only the minor, human-created fake "earthquake" at the Santa Ana reactor occurred, as the charges had been set before the book was published; the book predicts the "earthquake"), a nuclear disaster and major financial theft were averted.

Martin spoke about this, and the other real events described in the book, in a number of radio interviews he gave in 2012, the year the book was published.

Steve H. October 22, 2016 at 8:37 am

Not sure if this is meta or not:

"Here's the [Machine] trick: Design the machine that will produce the result your analysis indicates occurs routinely in the situation you have studied. Make sure you have included all the parts – all the social gears, cranks, belts, buttons, and other widgets – and all the specifications of materials and their qualities necessary to get the desired result."

Howard S. Becker

JTMcPhee October 22, 2016 at 8:58 am

Well, great! That part of the great discourse has been decoded and unpacked and all that, I feel much better for the personal increase in awareness of how fokked things are.

Now, how are "we" going to get billions of other humans to the same state of awareness, to stop talking about "fuel" when talking (using a gazillion other "terms of art" and memes and tropes that are similarly opaque and whitewash and FUD-laden) about "the economy" and "economics" and while generating ever more momentum for those same deadly (but profitable for the few) terms, tropes, memes and shorthands? "Profitable" being one of them, "profit" being part of the disease process, because after all, for the individual or the firm s/he belongs to, "profit" (ignoring externalities, of course) is the summum bonum that lets you buy stuff and experiences galore?

Other Juggernaut words, just a very few: "bonus", "healthcare", "entitlement", "MArket", "free trade," and a personal favorite, "donor" meaning very simply "BRIBER/corrupter" but hey, those very few squillionaires who own everything including the "political process" are described millions of times a DAY on the intertubes as "donors," "donors" to political candidates and PACs and "think tanks" (??another fave). Giving a kidney to a person with terminal kidney failure, "donating" one's corneas and body parts or those of deeply loved ones suddenly deceased, those are ""donations." Not Koch or Adelman or Soros or Gates etc. billions to "Foundations" or operas or art museums.

"We," who are Aware, perceive some of this, often argue and debate and cavil over nitty bits of those perceptions. That is so very effective, isn't it, the few hundreds or thousands of "us" who participate in or observe the Flow in NCspace, in bringing about any kind of regression to a mean that is hardly defined or maybe undefinable, a mean that might actually be "kind" and "decent" and "fair" and "just" (whatever those terms are taken to mean)?

What is to be done about it? "We" ain't either powerful or certain enough to do something like a "global search and replace" across the entire internet, with a burning of all the books and papers, and a quarantine of all the GeithnerDimonGreenspanKrugmans and their myriad of citers and followers and extenders, that carry the infection forward into the label minds of future "policy makers" who like most humans who (I am assured by others) are wired to seek dominance and pleasure and reproductive success? And who obviously are the dominant, successful vector and segment of the "political economy?"

The plagues that Pandora was tricked into loosing on "humanity" have been out there probably too long to be re-packaged. Nice effort for those who try, try and try again, but that effort seems to me mostly pissing into the wind…

griffen October 22, 2016 at 9:27 am

TINA. Sadly it's true, we appear somewhat stuck in this mode of what's working. I personally appreciate the credit union / co-op model of accomplishing financial intermediation but that is also a continuation of what we have.

Biggest problem in the US, no one competing with the FED.

Dave October 22, 2016 at 11:40 am

"some of the recent coinages, like "sharing economy" are downright Orwellian". Yes, but that phrase can be and is easily replaced in casual conversation with "the sharecropper economy". (Be prepared to deliver a short explanation what a sharecropper is to the youg 'uns.)

Another valid word out of the past is "the man," as in the giver of overpriced credit to the sharecropper who often ended up with zero profits and thus was kept in perpetual debt. Central bankers?

"The company store" is another one. Applepay?

"Papal indulgences" another. Hillary?

Word substitution is a fun game.

Dave October 22, 2016 at 11:48 am

Speaking of Big Brother, how can we forget "Thought leader"

diptherio October 22, 2016 at 12:24 pm

Everybody talks about "thought leaders" but no one ever talks about "thought followers," much less actually claims to be one. But without "thought followers" how can you have "thought leaders"? I'm suspicious….

And anyway, wouldn't "thought leader" be applicable to anybody whose thinking ends up being followed by others, for good or ill? Wouldn't Charles Manson be a "thought leader"? He certainly was for the Manson Family….just a thought…

Jeremy Grimm October 22, 2016 at 5:33 pm

I always thought the exhortation to be thought leaders was a ruse for encouraging people to speak up and try to act as thought leaders. That way those who worked us could identify the taller daisies and thereby identify which flowers to top.

Steven October 22, 2016 at 12:28 pm

Seems like some combination of Frederick Soddy and Michael Hudson is called for here. Soddy is apparently a tough slog even for otherwise intelligent people. So at the risk of over-simplification here is my attempt to convey his ideas about money and wealth:

Money is not wealth. It is a claim on wealth, i.e. debt.

Wealth. Soddy provides both a practical and a more abstract definition of (the ingredients of) wealth:

"But economics, in a national sense, is concerned with wealth as what is produced by human beings to maintain their lives.

Discovery, Natural Energy and Diligence, the Three Ingredients of Wealth

For Discovery, think research and development (R&D) and of course education so R&D is even possible. For Natural Energy, think, for most of the Industrial Revolution (IR), fossil fuels. (Pretty obviously we need to do something different if we want to keep the machine the IR built functioning, sustainably producing the wealth which sustains our civilization.)

One of my favorite passages from Soddy's "Wealth, Virtual Wealth and Debt" is:

"As Ruskin said, a logical definition of wealth is absolutely needed for the basis of economics if it is to be a science."

But without a science-based definition of wealth, i.e. continuing to use profit and money as a measure of 'productivity', just 'printing' more money (even Hudson's MMT) will solve nothing. Put these observations together and you get an idea what should 'back' money – wealth not gold or as Hudson puts it "Debts that can't be repaid (and) won't be."

Hudson's 'clean slate' provides the other part of the solution. As Hudson notes, the 'miracle of compound interest' is not sustainable – particularly when the West's 'financial engineers' are busy cranking out money (as debt) at rates well in excess of going interest rates. Just continuing to use profit and money as a measure of 'productivity', 'printing' more money (even Hudson's MMT) will solve nothing. Probably by the middle of the 20th century, the West had 'enough' wealth its people could begin to find other purposes in life than creating ever more of it (to make ever more money, i.e. acquire ever more debt to be paid by someone – the unborn?). Again from Soddy / Ruskin – real "Wealth rots." That's what's happening to the West's 'culture' as its ruling classes mindlessly attempt to acquire ever more money.

It isn't just the 1% who are going to have to take their lumps, to stop playing games with the world's future so they can, as candidate Trump put it, 'run up a bigger score' with money for which they have no immediate need. It is those of us in the 99% who do not possess the skills and aptitudes required for the genuine creation of wealth, wealth the world needs and can sustainably afford. Those numbers are going to grow as the Industrial Revolution succeeds, with human labor and rote intelligence replaced more and more by machines powered by "natural energy". But, even if we can't find our niche, I take it as a given that we are all born with a right to life.

Moneta October 22, 2016 at 1:27 pm

Wealth is hard to define because what we view as wealth might be a money pit that guarantees our decline…

For example, instead of injecting money directly in the faculty of medicine, a university might have decided to fund a football team to attract the capital and end up building a stadium… Instead of just funding the faculty.

All these activities related to the sports team contribute to GDP. The bankers might have been productive and efficient in raising capital, the coach might be productive and make a winning team, the builders of the stadium might have been very productive building a fine structure but all these activities sucked up resources and energy that could have been used by other sectors to better serve the future of the country. Maybe these activities are totally unsustainable. They might appear as wealth currently but will lead to poverty over time.

Since ou basic needs have been met, we have been investing in a forever greater number of non-essential resource intensive activities which show how disconnected we have become from the earth supporting us.

redleg October 22, 2016 at 12:50 pm

All the analogues to fuel and engines, yet nobody takes the next step to Power. Power is the key to both engines and finance.

Hudson, Black, Keen and other non-mainstream people are exceptions, but is anyone listening to them besides this choir?

Edward Morbius October 22, 2016 at 8:51 pm

"Wealth, as Mr Hobbes says, is power." Adam Smith, Wealth of Nations . It's only the second discussion (after definition) of the term in the book.

Smith doesn't get everything right, but he's considerably more savvy and left-wing, bleeding-heart liberal than he's commonly given credit for.

Les Swift October 22, 2016 at 1:13 pm

The terminology of finance is designed to hide predatory and extractive activities behind a curtain of beneficial-sounding words. These terms are deeply embedded, and serve both to put some friendly makeup on the business, and allow the "consumers" to feel better about their capitulation. The process is akin to the way politicians wrap themselves in the flag while they sell out the citizenry. We know deep down that they are lying, but we prefer the false patriotism because it serves the lies we prefer to tell ourselves. We bitch and moan, but we play our part, because not doing so leads to trouble. It is the way most of us live our lives.

One of the biggest problems people face in discussing matters financial, is that the very terminology of the system undercuts the critiques. Just as criticizing the wars invokes in some the specter of failing to support the troops and the specter of criticizing America, criticizing Wall Street's predatory aspects invokes in many the specter of criticizing institutions we have been led to believe represent the essence of American freedom. Doing so makes you at least a malcontent or troublemaker, and maybe even some sort of subversive pinko. Either way, you're rocking a boat many do not want rocked.

Using analogies and metaphors to discuss such matters can outflank the loaded-terminology question to a significant degree. You can cut through a lot of the fog of jargon by describing the activities in other terms. (E.g., Dave's "sharecropping" for "sharing economy.")

We are in an era in which the financial world is being downsized and consolidated, the giant speculative bubble which dominated most of our lives is being deflated and wound down before our eyes. There is still speculative activity, to be sure, but there is also a rise in the use of rentier income. This downsizing process involves shifting losses wherever possible down the food chain, including to institutions which previously were integral parts of the system. Insiders are finding themselves outsiders, jettisoned by other insiders.

This reminds me of the situation of a pack of wolves, grown large in an era of plentiful food, but now finding that food supply dwindling. The pack must shrink to survive, the excess members culled in often brutal ways. The strongest eat the most, the rest are left with the scraps, or nothing at all. The financial system is similar, a pack in which the herd is being culled. Individual institutions, even important ones like Barings or Lehman, are ephemeral. They come and they go, just like individual wolves in the pack. But the pack lives on, and so does the financial system. To the wolves, the pecking order, who lives and who dies, is very important. But for the creatures the pack eats, such concerns are irrelevant.

tongorad October 22, 2016 at 2:40 pm

Either way, you're rocking a boat many do not want rocked.

Perhaps. Or perhaps the alternatives to our ruling narratives and power mechanisms have been ruthlessly dismantled and extinguished. For example, I would love to join a union. But I live in a right-to-work state.

I would love to have representation at my workplace and have some degree of bargaining power. I guess there's always the complaint box. Or the "freedom" to hit the bricks.

Luckily, I went to school when it was affordable, so I don't have student loan debt. I rent, and although rents continue to rise every year, I don't have a mortgage hanging over my head.

My younger colleagues are saddled with outrageous student loan debt that they will never likely repay. Unfortunately many/most of them bought into the housing market. How likely are they to even entertain the idea of speaking truth to power?

I'm past 50, and you know what that means to my prospects of finding another job. Young and old, we just keep our mouths shut and do what we're told.

moneta October 22, 2016 at 2:44 pm

The US represents 5% of world population but consumes a much larger share of world energy and resources. The 99% are concerned about fairness but if they truly cared, they'd understand that the global economy needs to shrink their share of resources to 5%. And the leveling is getting stronger by the day. Most people go along the big lie because of hope.

Jeremy Grimm October 22, 2016 at 5:51 pm

Question about your numbers - I think our share of resources needs to shrink but I'm not sure 5% is the right number. Are some of the resources in that 5% dedicated to our Industry? Is our industry productive? and who gets the stuff? It may be we need to shrink our use of resources to 4%. And what about the who uses how much of what resources? How do you count the resources used to support our car, bus, and truck industries while deliberately stifling mass transit. I only make these quibbles to avoid your logic of proportions. Clearly we must take/steal less from the rest of the world and share what we have. I believe there is enough to go around - once a few (quite a few) problems here and there are taken care of.

I'm not sure how much hope continues to hold up the big lie. I think the supports for the big lie need a lot of maintenance to keep it from falling. Maybe we can simply stop using that road.

moneta October 22, 2016 at 6:13 pm

I don't know what the number is but from my vantage point , it looks like the western work is heading for a world of pain. Americans want America to be great again but it's based on materialism.

To be great again would mean a different kind of greatness where the economy is based on a reduction of it share of resources.

But the population is still very far away from the fact that its way of life depends on an unfair distribution of world resources which will probably lead to a big world struggle meaning a focus on the military.

This is not what I want by what I see in the horizon.

There's a reason money and fuel are in the same sentence. It's because the a nation's power depends on energy.

Vatch October 22, 2016 at 8:25 pm

It might seem trite, but if an American is patriotic, he or she will try to reduce the nation's energy use by using energy efficiently. Whether it's transportation, home heating, home cooling, or nighttime illumination, one should use the energy efficiently. Aside from the immorality of using so much more than many other people in the world, it's a way to reduce pollution and to avoid sending money to the Wahhabi nut jobs in Saudi Arabia. Plus, energy efficiency saves money!

Jeremy Grimm October 22, 2016 at 8:39 pm

I think you and I are on the same page.

Our country has the capacity to help the world get through the crises of Global Warming and the end of oil. Our country has responsibility as one of the guilty parties - one of the most most guilty in taking more than our share and sharing less than we are able or should share. The meaning of riches is best enjoyed through the sharing of those riches. In ancient times - at least in some places - that was the privilege and obligation of the rich.

I would feel deep shame for our country if it is to be remembered in the future for what it has done so far.

Orn October 22, 2016 at 1:17 pm

An alternate metaphor could be the slime mold .

knowbuddhau October 22, 2016 at 2:48 pm

Great comment, ROTL! Accords very well with my understanding of the power of metaphors, to bring into being the world stage on which we strut our stuff.

Many here at NC often comment on the quasi-religious nature of economics. I'm always struck by the conflation of the organic/natural world with mechanics. Wrongly conceiving of market forces as natural forces and so on. I think you've struck a blow against this wrong-headed mythos at its weakest point. If the metaphors that bring into being this world of pain we're living in themselves are discredited, the whole edifice could come crashing down in no time.

If anyone's interested in a little exercise, trying paying attention to the metaphors one uses for organic systems, and society at large. Even though I'm aware of their inappropriateness, it's hard not to think in mechanistic terms. And not just mechanistic, but weaponized, at that. You can't even listen to a baseball game without hearing metaphors of war all the damn time. Then there are "Twitter wars" and "Facebook wars" ad nauseaum.

I like lyman alpha blob's mention of financial warfare, too. In 2010, forensic economists found confirmation of the "economic hit man hypothesis" by studying the effectiveness of the CIA's overseas efforts wrt US exports.
http://www.slate.com/articles/business/the_dismal_science/2010/05/industrial_espionage.html

If we agree that we need a most fundamental and profound change to our ways of being in the world, our use of metaphors is a great place to start.

Wade Riddick October 22, 2016 at 6:46 pm

Money is nutrition, not a snack. It's food and fertilizer. It makes things grow. You have to share it with other life like bacteria and worms: without these organisms in your gut ecology, you get sick (autism, diabetes, obesity, M.S.). Idiots try to convince us these organisms are parasites instead of symbionts just like Monsanto thinks bees are disposable or Donald Trump likes to think of pregnant women as drags on business profits.

Where does he propose business find future workers if not in wombs? From where will his future customers come?

Perhaps in sharing economy of future America, companies will have to share their dwindling customers and make do with less?

If you think altruism is for suckers, your Ayn Rand economy collapses because you confuse parasites with symbionts and symbionts with parasites. You can't distinguish between compensation for earned and unearned income. What's a tax and what's theft? Try living without bacteria making butyrate in your gut. Wells Fargo can no more survive without little people like airport janitors to scrub out the TB and Ebola stains than our cells can breathe without mitochondria. Yet who gets their pay driven down in corporate America?

Money weaves a supporting web of trust, a mutual network of obligations and payments – and what happens biologically when that web inside us is broken and friends become enemies and we treat enemies as friends? Is fraud any different than autoimmunity or cancer?

readerOfTeaLeaves October 22, 2016 at 7:16 pm

Well, I was gobsmacked to see this show up when I finally logged on to the Internet today. Many heartfelt thanks to all who commented so thoughtfully and insightfully; and also to the remarkable NC crew (Yves, Lambert, Jerri-Lynn, the IT folks), as well of course to Clive.

I think that we are all rooting for the time when Haldane's insights are met with 'Doh', and when we celebrate Bill Black as a Nobel in Economics ;-)

[Sep 27, 2016] DeLong on helicopter money

Sep 27, 2016 | economistsview.typepad.com

Peter K. : September 27, 2016 at 06:45 AM DeLong on helicopter money: "The swelling wave of argument and discussion around "helicopter money" has two origins:

First, as Harvard's Robert Barro says: there has been no recovery since 2010.

The unemployment rate here in the U.S. has come down, yes. But the unemployment rate has come down primarily because people who were unemployed have given up and dropped out of the labor force. Shrinkage in the share of people unemployed has been a distinctly secondary factor. Moreover, the small increase in the share of people with jobs has been neutralized, as far as its effects on how prosperous we are, by much slower productivity growth since 2010 than America had previously seen, had good reason to anticipate, and deserves.

The only bright spot is a relative one: things in other rich countries are even worse.
..."

I thought Krugman and Furman were bragging about Obama's tenure.

"Now note that back in 1936 [John Maynard Keynes had disagreed][]:

"The State will have to exercise a guiding influence... partly by fixing the rate of interest, and partly, perhaps, in other ways.... It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself.... I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative..."

By the 1980s, however, for Keynes himself the long run had come, and he was dead. The Great Moderation of the business cycle from 1984-2007 was a rich enough pudding to be proof, for the rough consensus of mainstream economists at least, that Keynes had been wrong and Friedman had been right.

But in the aftermath of 2007 it became very clear that they-or, rather, we, for I am certainly one of the mainstream economists in the roughly consensus-were very, tragically, dismally and grossly wrong."

DeLong sounds very much left rather than center-left. His reasons for supporting Hillary over Sanders eludes me.

Hillary's $275 billion over 5 years is substantially too small as center-leftist Krugman put it.

Now we face a choice:

Do we accept economic performance that all of our predecessors would have characterized as grossly subpar-having assigned the Federal Reserve and other independent central banks a mission and then kept from them the policy tools they need to successfully accomplish it?

Do we return the task of managing the business cycle to the political branches of government-so that they don't just occasionally joggle the elbows of the technocratic professionals but actually take on a co-leading or a leading role?

Or do we extend the Federal Reserve's toolkit in a structured way to give it the tools it needs?

Helicopter money is an attempt to choose door number (3). Our intellectual adversaries mostly seek to choose door number (1)-and then to tell us that the "cold douche", as Schumpeter put it, of unemployment will in the long run turn out to be good medicine, for some reason or other. And our intellectual adversaries mostly seek to argue that in reality there is no door number (3)-that attempts to go through it will rob central banks of their independence and wind up with us going through door number (2), which we know ends badly..."

------------

Some commenters believe more fiscal policy via Congress is politically more realistic than helicopter money.

I don't know, maybe they're right. I do know Hillary's proposals are too small. And her aversion to government debt and deficit is wrong given the economic context and market demand for safe assets.

Some pundits like Krugman believe helicopter money won't be that effective "because the models tell him." We should try it and find out. Reply Tuesday, September 27, 2016 at 06:45 AM

reason -> Peter K.... , Tuesday, September 27, 2016 at 08:40 AM

"Moreover, the small increase in the share of people with jobs has been neutralized, as far as its effects on how prosperous we are, by much slower productivity growth since 2010 than America had previously seen, had good reason to anticipate, and deserves."

?????? The rate of (measured) productivity growth is not all that important. What has happened to real median income.

And why are quoting from Robert Barro who is basically a freshwater economist. Couldn't you find somebody sensible?

pgl -> reason ... , Tuesday, September 27, 2016 at 09:08 AM
Barro wants us to believe we have been at full employment all along. Of course that would mean any increase in aggregate demand would only cause inflation. Of course many of us think Barro lost it years ago.

These little distinctions are alas lost on PeterK.

Peter K. -> pgl... , Tuesday, September 27, 2016 at 01:05 PM
run a long stupid troll.

Go read some hack Republican analyses.

Peter K. -> reason ... , Tuesday, September 27, 2016 at 01:06 PM
DeLong is quoting Barro.
Paine -> Peter K.... , Tuesday, September 27, 2016 at 09:57 AM
Really it's Delong on the context that has produced a return to HM fantasies

I'm sure u agree

He doesn't endorse HM in this post does he ?

Peter K. -> Paine ... , Tuesday, September 27, 2016 at 01:09 PM
Sounds to me like he does:

"Now we face a choice:

[1] Do we accept economic performance that all of our predecessors would have characterized as grossly subpar-having assigned the Federal Reserve and other independent central banks a mission and then kept from them the policy tools they need to successfully accomplish it?

[2] Do we return the task of managing the business cycle to the political branches of government-so that they don't just occasionally joggle the elbows of the technocratic professionals but actually take on a co-leading or a leading role?

[3] Or do we extend the Federal Reserve's toolkit in a structured way to give it the tools it needs?

Helicopter money is an attempt to choose door number (3). Our intellectual adversaries mostly seek to choose door number (1)-and then to tell us that the "cold douche", as Schumpeter put it, of unemployment will in the long run turn out to be good medicine, for some reason or other. And our intellectual adversaries mostly seek to argue that in reality there is no door number (3)-that attempts to go through it will rob central banks of their independence and wind up with us going through door number (2), which we know ends badly...""

---------------------
Conservatives want 1 and 2 ends badly, so 3 is the only choice.

[Sep 12, 2016] http://krugman.blogs.nytimes.com/2009/10/09/modified-goldbugism-at-the-wsj/

Sep 12, 2016 | blogs.nytimes.com

October 9, 2009

Modified Goldbugism At the WSJ
By Paul Krugman

So I was peacefully drinking my coffee this morning, and was accosted by someone waving the latest Wall Street Journal editorial on the dollar * in my face, demanding my reaction. Um, this is not cool. Also, with apologies to Brad DeLong, when reading WSJ editorials you need to bear two things in mind:

1. The WSJ editorial page is wrong about everything.
2. If you think the WSJ editorial page is right about something, see rule #1.

After all, here's what you would have believed if you listened to that page over the years: Clinton's tax hike will destroy the economy, you really should check out those people suggesting that Clinton was a drug smuggler, Dow 36000, the Bush tax cuts will bring surging prosperity, Saddam is backing Al Qaeda and has WMD, there isn't any housing bubble, US households have a high savings rate if you measure it right. I'm sure I missed another couple of dozen high points.

Today's editorial was in the grand tradition. A few months ago falling stock prices showed Obama's failure - never mind, we meant the falling dollar. And just to provide extra spice, the editorial cited David Malpass ** as the wise expert on all this.

But more specifically, you need to see the Journal's fear of a weak dollar in terms of its long-term gold-bug position. The Journal has always maintained that changes in exchange rates play no useful role, that stable exchange rates - preferably enforced by some barbarous relic like the gold standard - are the essence of sound policy.

I explained why this is all wrong a long time ago. *** But it's especially important to understand the wrongness of this view right now. If there's one overwhelming lesson from the Great Depression, it is that putting a higher priority on stabilizing your currency than on domestic recovery is utterly disastrous. Barry Eichengreen **** pointed out years ago that major economies went off gold in the following order: Japan, Britain, Germany, US, France. And here's what happened to their industrial output:

[Slowest to leave the gold standard, slowest to recover.
All that glitters went off gold.]

The WSJ may not realize it, but it wants us to be France in the 1930s. Let's not.

* http://online.wsj.com/article/SB10001424052748703746604574461473511618150.html

** http://bigpicture.typepad.com/comments/2008/03/malpass-ass.html

*** http://www.pkarchive.org/cranks/goldbug.html

**** http://braddelong.posterous.com/eichengreen-origins-and-nature

Reply Saturday, November 14, 2015 at 05:19 PM

anne said in reply to anne...

http://www.pkarchive.org/cranks/goldbug.html

November 22, 1996

The Gold Bug Variations
By Paul Krugman - Slate

The legend of King Midas has been generally misunderstood. Most people think the curse that turned everything the old miser touched into gold, leaving him unable to eat or drink, was a lesson in the perils of avarice. But Midas' true sin was his failure to understand monetary economics. What the gods were really telling him is that gold is just a metal. If it sometimes seems to be more, that is only because society has found it convenient to use gold as a medium of exchange--a bridge between other, truly desirable, objects. There are other possible mediums of exchange, and it is silly to imagine that this pretty, but only moderately useful, substance has some irreplaceable significance.

But there are many people--nearly all of them ardent conservatives--who reject that lesson. While Jack Kemp, Steve Forbes, and Wall Street Journal editor Robert Bartley are best known for their promotion of supply-side economics, they are equally dedicated to the belief that the key to prosperity is a return to the gold standard, which John Maynard Keynes pronounced a "barbarous relic" more than 60 years ago. With any luck, these latter-day Midases will never lay a finger on actual monetary policy. Nonetheless, these are influential people--they are one of the factions now struggling for the Republican Party's soul--and the passionate arguments they make for a gold standard are a useful window on how they think.

There is a case to be made for a return to the gold standard. It is not a very good case, and most sensible economists reject it, but the idea is not completely crazy. On the other hand, the ideas of our modern gold bugs are completely crazy. Their belief in gold is, it turns out, not pragmatic but mystical.

The current world monetary system assigns no special role to gold; indeed, the Federal Reserve is not obliged to tie the dollar to anything. It can print as much or as little money as it deems appropriate. There are powerful advantages to such an unconstrained system. Above all, the Fed is free to respond to actual or threatened recessions by pumping in money. To take only one example, that flexibility is the reason the stock market crash of 1987--which started out every bit as frightening as that of 1929--did not cause a slump in the real economy.

While a freely floating national money has advantages, however, it also has risks. For one thing, it can create uncertainties for international traders and investors. Over the past five years, the dollar has been worth as much as 120 yen and as little as 80. The costs of this volatility are hard to measure (partly because sophisticated financial markets allow businesses to hedge much of that risk), but they must be significant. Furthermore, a system that leaves monetary managers free to do good also leaves them free to be irresponsible--and, in some countries, they have been quick to take the opportunity. That is why countries with a history of runaway inflation, like Argentina, often come to the conclusion that monetary independence is a poisoned chalice. (Argentine law now requires that one peso be worth exactly one U.S. dollar, and that every peso in circulation be backed by a dollar in reserves.)

So, there is no obvious answer to the question of whether or not to tie a nation's currency to some external standard. By establishing a fixed rate of exchange between currencies--or even adopting a common currency--nations can eliminate the uncertainties of fluctuating exchange rates; and a country with a history of irresponsible policies may be able to gain credibility by association. (The Italian government wants to join a European Monetary Union largely because it hopes to refinance its massive debts at German interest rates.) On the other hand, what happens if two nations have joined their currencies, and one finds itself experiencing an inflationary boom while the other is in a deflationary recession? (This is exactly what happened to Europe in the early 1990s, when western Germany boomed while the rest of Europe slid into double-digit unemployment.) Then the monetary policy that is appropriate for one is exactly wrong for the other. These ambiguities explain why economists are divided over the wisdom of Europe's attempt to create a common currency. I personally think that it will lead, on average, to somewhat higher European unemployment rates; but many sensible economists disagree.

So where does gold enter the picture?...

Reply Saturday, November 14, 2015 at 05:21 PM

ax

[Apr 17, 2016] Towards a Theory of Shadow Money by Daniela Gabor

Notable quotes:
"... Minsky famously quipped that everyone can create new money; the problem is to get it accepted as such by others. ..."
"... But even money-proper is not the same for everyone. Central banks create the money in which banks pay each other, while private banks create money for households and firms. Money is hierarchical , and moneyness is a question of immediate convertibility without loss of value (at par exchange, on demand). ..."
"... To convert shadow money into settlement money in case of default, repo lenders sell collateral. An intricate collateral valuation regime, consisting of haircuts, mark-to-market, and margin calls, maintains collateral's exchange rate into (central) bank money. ..."
"... What makes repos money – at par exchange between "cash" and collateral – is what makes finance more fragile in a Minskyan sense. ..."
"... Liquid markets become more fragile, he argued, by giving investors the "illusion" that they can exit before prices turn against them. This is a crucial insight for crises of shadow money. ..."
"... Criminality and corruption is embedded at the top of the financial food chain, by law. ..."
"... Motion seconded: Government sanctioned counterfeiting. ..."
"... …and does anyone remember the triumph of the desk slaves of the Crimson Permanent Assurance? Monty Python understood something about political economies and how one might achieve more fairness in outcomes… https://vimeo.com/111458975 ..."
"... Shadow money sounds to me like fictional capital by another name. And contractual based deposits sounds like counterfeiting. With the distinction that the man with counterfeit printing press robs the train, while the man who runs the Wall St Investment bank repo trading desk robs the whole railroad. ..."
"... Therefore, Money becomes a victim of the ontological argument for God by St Anselm. If God does not exist, an all powerful, all knowing, all present infinitely great in all categories of Supreme Being could not be written or spoken about, lacking the quality of existence. The fact that we CAN speak about an Omnipotent Supreme Deity means that one in fact exists, due to existence is part and parcel of Omnipotence. But of course, because we can talk or write about something, does not make it real. ..."
"... It can become socially acceptable as in the case of shadow money, but it is fictional capital, a shadow of the real thing. Time to get out of the cave of finance with its shadows dancing from the light of the fires and walk eyes wide open in the bright light of sunshine! ..."
"... Money is actually the easiest thing to write about, because it's formless energy. It's not that the phenomenon is shadow money, it's shadow assets. ..."
"... You have to be able to separate in your mind the ideas of 1) Quantity and 2) Form. That's why economics is a mental disorder, because it doesn't separate quantity and form. If you can't or don't, then yes, it's diabolically hard to write about because you're writing about two different things simultaneously without realizing it. Money is a quantity that is infinite and continuous, but form is an idea that is discontinuous and finite. People do what the forms tell them to do. The money is just like electricity that powers the animation of the forms. Repo is a form it's not money. It's existence results in a certain ordering of social relations, that's also a form. But money is just the energy that makes the forms potent. ..."
"... I guess that's why they used to call it "political economy" before the mental disorder fully usurped the power of perception and reasoning. ..."
"... Marx failed to acknowledge that supposedly hard-headed Capitalism is actually all about living beyond your means and mortgaging the future. ..."
"... It was designed from the Fuggars' and the Medici's to be about debt and fractional reserves and interest. A system based on a finite supply of money is going to grow not much faster, at best, than the money available allows. ..."
"... Capitalism allows explosive growth by supplying explosive amounts of credit. All this shadow banking activity is designed to get around reserve requirements; nothing else I can see calls all this complexity into existence. The banks always need more, because lending is how they make their money, so they want an infinite amount to lend in order to drive their profits towards the infinite. ..."
"... This article I think defines shadow money alright as starting where bank deposits leave off but as the above comments suggest seems to miss some key points. I think a major problem with the article is seeing central banks as separate from the state rather than seeing the central bank along with the Treasury as the state itself. ..."
"... The article gets Treasury debt wrong by seeing it as the central bank funding the state rather than as actually coming from the state. This leads to wrong policy choices such as this state money being used to bail out useless financial transactions and asset appreciation rather than the public purpose. I think crazyman has it right. We left behind the power of perception and reasoning by not realizing the importance of political economy . ..."
"... This is reminscent of Gramsci's idea that the state and civil society are to be distinguished only for purposes of exposition. ..."
April 16, 2016 | www.nakedcapitalism.com

By Daniela Gabor, associate professor in economics at the University of the West of England, Bristol, and Jakob Vestergaard, senior researcher at the Danish Institute for International Studies. Originally published at the Institute for New Economic Thinking website

Struggles over shadow money today echo 19th century struggles over bank deposits.

Money, James Buchan once noted , "is diabolically hard to write about." It has been described as a promise to pay, a social relation, frozen desire , memory, and fiction. Less daunted, Hyman Minsky was interested by promises of unknown and changing properties . "Shadow" promises would have fascinated him. Indeed, Perry Mehrling, Zoltan Pozsar , and others argue that in shadow banking, money begins where bank deposits end. Their insights are the starting point for the first paper of our Institute for New Economic Thinking project on shadow money. The footprint of shadow money, we argue,* extends well beyond opaque shadow banking, reaching into government bond markets and regulated banks. It radically changes central banking and the state's relationship to money-issuing institutions.

Minsky famously quipped that everyone can create new money; the problem is to get it accepted as such by others. General acceptability relies on the strength of promises to exchange for proper money, money that settles debts. Banks' special role in money creation, Victoria Chick reminds us, was sealed by states' commitment that bank deposits would convert into state money (cash) at par. This social contract of convertibility materialized in bank regulation, lender of last resort, and deposit guarantees.

But even money-proper is not the same for everyone. Central banks create the money in which banks pay each other, while private banks create money for households and firms. Money is hierarchical , and moneyness is a question of immediate convertibility without loss of value (at par exchange, on demand).

Using a money hierarchy lens, we define shadow money as repurchase agreements (repos), promises to pay backed by tradable collateral. It is the presence of collateral that confers shadow money its distinctiveness. Our approach advances the debate in several ways.

First, it allows us to establish a clear picture of modern money hierarchies. Repos are nearest to money-proper, stronger in their moneyness claims than other short-term shadow liabilities . Repos rose in money hierarchies as finance sidestepped the state, developing its own convertibility rules over the past 20 years. To convert shadow money into settlement money in case of default, repo lenders sell collateral. An intricate collateral valuation regime, consisting of haircuts, mark-to-market, and margin calls, maintains collateral's exchange rate into (central) bank money.

Second, we put banks at the center of shadow-money creation. The growing shadow-money literature, however original in its insights, downplays banks' activities in the shadows because its empirical terrain is U.S. shadow banking with its institutional peculiarities. There, hedge funds issue shadow money to institutional cash pools via the balance sheet of securities dealers. In Europe or China , it's also banks issuing shadow money to other banks to fund capital market activities. LCH Clearnet SA, a pure shadow bank, offers a glimpse into this world. Like a bank, it backs money issuance with central bank (Banque de France) money. Unlike a bank, LCH Clearnet only issues shadow money.

Third, we explore the critical role of the state beyond simple guarantor of convertibility. Like bank money, shadow money relies on sovereign structures of authority and credit worthiness. Shadow money is mostly issued against government bond collateral, because liquid securities make repo convertibility easier and cheaper. The legal right to re-use (re-hypothecate) collateral allows various (shadow) banks to issue shadow money against the same government bond, which becomes akin to a base asset with "velocity." Limits to velocity place demands on the state to issue debt, not because it needs cash but because shadow money issuers need collateral.

With finance ministries unresponsive to such demands, we note two points in the historical development of shadow money in the early 2000s. In the United States, persuasive lobbying exploited concerns that U.S. Treasury debt would fall to dangerously low levels to relax regulation on repos collateralized with asset and mortgage-backed securities . In Europe, the ECB used the mechanics of monetary policy implementation to the same end. When it lent reserves to banks via repos, the ECB used its collateral valuation practices to generate base-asset privileges for "periphery" government bonds, treating these as perfect substitutes for German government bonds, with the explicit intention of powering market liquidity.

Fourth, we introduce fundamental uncertainty in modern money creation. What makes repos money – at par exchange between "cash" and collateral – is what makes finance more fragile in a Minskyan sense. Knightian uncertainty bites harder and faster because convertibility depends on collateral-market liquidity.

The collateral valuation regime that makes repos increasingly acceptable ties securities-market liquidity into appetite for leverage. Here, Keynes' concerns with the social benefits of private liquidity become relevant. Keynes voiced strong doubts about the idea of "the more liquidity the better" in stock markets (concerns now routinely voiced by central banks for securities markets). Liquid markets become more fragile, he argued, by giving investors the "illusion" that they can exit before prices turn against them. This is a crucial insight for crises of shadow money.

A promise backed by tradable collateral remains acceptable as long as lenders trust that collateral can be converted into settlement money at the agreed exchange rate. The need for liquidity may become systemic once collateral falls in market value, as repo issuers must provide additional collateral or cash to maintain at par. If forced to sell assets, collateral prices sink lower, creating a liquidity spiral . Converting shadow money is akin to climbing a ladder that is gradually sinking: The faster one climbs, the more it sinks.

Note that sovereign collateral does not always stop the sinking, outside the liquid world of U.S. Treasuries. Rather, states can be dragged down with their shadow-money issuing institutions. As Bank of England showed , when LCH Clearnet tightened the terms on which it would hold shadow money backed with Irish and Portuguese sovereign collateral, it made the sovereign debt crisis worse. Europe had its crisis of shadow money, less visible than the Lehman Brothers demise, but no less painful. "Whatever it takes" was a promise to save the "shadow" euro with a credible commitment to support sovereign collateral values.

Shadow money also constrains the macroeconomic policy options available to the state. That's because what makes shadow liabilities money also greatly complicates its stabilization: it requires a radical re-think of many powerful ideas about money and central banking. The first point, persuasively made by Perry Mehrling , and more recently by Bank of England , is that central banks need a (well-designed) framework to backstop markets , not only institutions . Collateralized debt relationships can withstand a systemic need for liquidity if holders of shadow money are confident that collateral values will not drop sharply, forcing margin calls and fire sales. Yet such overt interventions raise serious moral hazard issues.

Less well understood is that central banks need to rethink lender of last resort. Their collateral framework can perversely destabilize shadow money. Central banks cannot mitigate convertibility risk for shadow money when they use the same fragile convertibility practices. Rather, central banks should lend unsecured or without seeking to preserve collateral parity.

We suggest that the state, as base-asset issuer, becomes a de facto shadow central bank. Its fiscal policy stance and debt management matter for the pace of (shadow) credit expansion and for financial stability. Yet, unlike the central bank, the state has no means to stabilize shadow money or protect itself from its fragility. It has to rely on its central bank, caught in turn between independence and shadow money (in)stability, which may require direct interventions in government bond markets.

The bigger task that follows from our analysis, is to define the social contract between the three key institutions involved in shadow money: the state as base collateral issuer, the central bank, and private finance. In the new FSB or Basel III provisions, we are witnessing a struggle over shadow money with many echoes from the long struggle over bank money. The more radical options, such as disentangling sovereign collateral from shadow money, were never contemplated in regulatory circles. Even a partial disentanglement has proven difficult because states depend on repo markets to support liquidity in government bond markets. Our next step, then, will be to map how the crisis has altered the contours of the state's relation to the shadow money supply, comparing the cases of the U.S., the Eurozone, and China.

cnchal , April 16, 2016 at 4:10 am

Financial anarchy is my interpretation of shadow banking.

. . . The legal right to re-use (re-hypothecate) collateral allows various (shadow) banks to issue shadow money against the same government bond , which becomes akin to a base asset with "velocity." Limits to velocity place demands on the state to issue debt, not because it needs cash but because shadow money issuers need collateral .
----
The bigger task that follows from our analysis, is to define the social contract between the three key institutions involved in shadow money: the state as base collateral issuer, the central bank, and private finance .

Who does shadow banking serve? It is so far from capitalism, it should be illegal.

Bernie Sanders: The business of Wall Street is fraud and greed.

Robert Coutinho , April 16, 2016 at 7:32 am

Well…yes and no. There is real "need" for some shadow banking services. However, the idea of having Central Banks (issuers of money, or whatever) loaning based on … nothing?

Less well understood is that central banks need to rethink lender of last resort. Their collateral framework can perversely destabilize shadow money. Central banks cannot mitigate convertibility risk for shadow money when they use the same fragile convertibility practices. Rather, central banks should lend unsecured or without seeking to preserve collateral parity.

"Europe had its crisis of shadow money, less visible than the Lehman Brothers demise, but no less painful. "Whatever it takes" was a promise to save the "shadow" euro with a credible commitment to support sovereign collateral values."

Yes, but Lehman was not a taxing authority (although to be fair, Ireland et.al. were not money-issuing sources).

I am having a hard time understanding all of this–but as far as I can tell, the authors are basically suggesting that sovereign governments should be backing up the shadow banking system. However, I have not seen them suggest any reason for it except that the entire house of cards could come falling down. Boo hoo for the banksters–tell them to do things out of the "shadows".

Jujeb , April 16, 2016 at 4:20 am

Why is there a need for 'shadow money' in the first place?
Afaik, banks create money when they loan and central banks(especially the Fed) issues the most secure assets, their securities, which are used as collateral.

abynormal , April 16, 2016 at 7:44 am

Thanks Yves for sharing Gabor…what a Mess! towards the end of 2012 the US shadow banking was said to be around 67 Trillion …did something get baked-in? 2014 the IMF has a much smaller 'account'…(Japan being the worst laughing stock). the gaps are no small detail:

The IMF's latest Global Financial Stability Report analyzes the growth in shadow banking in recent years in both advanced and emerging market economies and the risks involved.

According to the report, shadow banking amounts to between 15 and 25 trillion dollars in the United States, between 13.5 and 22.5 trillion in the euro area, and between 2.5 and 6 trillion in Japan-depending on the measure- and around 7 trillion in emerging markets. In emerging markets, its growth is outpacing that of the traditional banking system. https://www.imf.org/external/pubs/ft/survey/so/2014/pol100114a.htm

Stephen Verchinski , April 16, 2016 at 9:34 am

That sure seems a Rx for destabilizing the world currencies to precipitate a collapse. Track and publicize the visits of Congressmen and Senators to the BIS and COL to start. Why are they making these visits under cover? Who are they meeting with? Are they being prepared as to what to expect a deliberate world currency crash? . Our political elite are so beholden to the bankers to allow for the theft of the wealth of nations for unattainable expanding growth and skimming of millions. Is it possible in regard the corporate banks to have the strings attached on the use of shadow money at time of chartering or in the case of the do over at time of bankruptcy?. How is this done? I'd also like to know a good proposal for the private investment boutique banks. Have any bills at state and federal levels been proposed and if not, why not? What would the main sections of such a bill look like. Thanks.

ke, April 16, 2016 at 8:04 am

A derivative promise made by a Wall Street prostitute, ultimately contingent upon the ability to liquidate the very users of the instrument, with currency debasement, and war to restock.

Paying people to buy stuff from others being paid to buy stuff, with the full faith and credit of dependent seniors in a collapsing actuarial ponzi, with nothing more than made for TV mercenaries, isn't likely to end well.

Craps, the bank moves to the next suckers, with nothing more than the promise of an exotic vacation, billed to someone else.

Steve H. , April 16, 2016 at 9:27 am

– Limits to velocity place demands on the state to issue debt, not because it needs cash but because shadow money issuers need collateral.

There's a dirty linchpin. Even if the diabolical multiplier from cnchal's quote were removed, and the dollar was hard-pinned to a pound of silver to pay the sheriff with, infinite debt issuance can step in to the feed the hungry beast.

Promises to pay kept mercenaries in line during the city-states. If you didn't win you didn't get paid. Unless you turned around and took your employers gold instead. Which is a bit like capturing the central banks.

Still, debt can be put to good uses. Infrastructure, maybe. Basic necessities and health. 'When the people are strong, the nation is strong.' Instead, the gearing seem like the machine in Princess Bride, sucking time from peoples lives.

Watt4Bob , April 16, 2016 at 10:06 am

With regard to velocity;

Ask any highway patrolman, the faster the speed limit, the worse the accidents.

On the famed autobahns of Europe, the no speed limit means that when an accident occurs, the results are likely to be catastrophic.

And I really love the observation that central banks need a mechanism to backstop the market.

Reminds me of the main problem with the famous Vincent Black Shadow motorcycle, it could attain speeds close to 200 mph, but brake designs at the time didn't work at those speeds, so as Hunter S. Thompson remarked;

"If you rode the Black Shadow at top speed for any length of time, you would almost certainly die."

Wall $treet wants to go fast, the faster the better, but they haven't got any brakes, and worse than that, we're all along for the ride whether we like it or not.

Jim Haygood , April 16, 2016 at 2:04 pm

Richard Thompson got it too:

Oh, says Red Molly to James, "That's a fine motorbike
A girl could feel special on any such like"
Says James to Red Molly, "My hat's off to you
It's a Vincent Black Lightning, 1952"

[James gets shot in a robbery]

When she came to the hospital, there wasn't much left
He was running out of road, he was running out of breath
But he smiled to see her cry
And said I'll give you my Vincent to ride

Oh, he reached for her hand then he slipped her the keys
He said, "I've got no further use for these
I see angels on Ariels, in leather and chrome
Swooping down from heaven to carry me home"

And he gave her one last kiss and died
And he gave her his Vincent to ride

It was sorta like that when Bernanke handed J-Yel the keys to his QE penny farthing bike.

Watt4Bob , April 17, 2016 at 9:09 am

I'd flesh out that analogy a bit;

The Bernanke and J-Yel witnessed the header that Greenspan took on that bike, and decided to leave it standing against the wall. When you consider the fact that neither of them could reach the pedals, let alone mount the thing and ride, that was probably a good idea.

Chauncey Gardiner , April 16, 2016 at 10:53 am

When did the central banks' framework to backstop markets morph into an organized effort to push the value of repo collateral relentlessly upward forever?…

What about increasing the relentless decline in the Velocity of Money by gradually increasing interest rates? Yes, that might be a catalyst to trigger a "liquidity spiral". So what? We now have moral hazard in spades and at some point will have to cross the Rubicon, whether willingly or not.

washunate , April 16, 2016 at 11:38 am

Here's a simple theory: Shadow banking is government approved fraud.

cnchal, April 16, 2016 at 12:07 pm

i am reading one of the links from the post titled "Regulating money creation after the crisis", and it's even worse than government approved fraud. I am only part way through it, but here is a gem.

On page 10

. . . Instead, OLA was designed to preserve the value of the assets of failed financial firms until they are liquidated, a worthy aim, but a very different one. At the same time, the Dodd-Frank Act has imposed significant new limitations on the government's freestanding panic-fighting tools . These limitations, absent future congressional action, would render next to impossible the kind of aggressive government rescue operation that was staged during the recent crisis.

Criminality and corruption is embedded at the top of the financial food chain, by law.

Paul Tioxon , April 16, 2016 at 2:20 pm

Motion seconded: Government sanctioned counterfeiting.

Keith , April 16, 2016 at 11:54 am

Before we complicate the issue, it is fairly obvious no one understands conventional money and it is one of the best kept secrets on the planet.

Learn how normal money works and how its mismanagement has led to many of today's problems.

Banks create money out of nothing to allow you to buy things with loans and mortgages (fractional reserve banking).

After years of lobbying the reserve required is often as good as nothing. Mortgages can be obtained with the reserve contained in the fee.

After the financial crisis there were found to be £1.25 in reserves for every £100 issued on credit in the UK.

Having no reserve shouldn't be a problem with prudent lending.

Creating money out of nothing is the service they really provide to let you spend your own future income now.

They charge interest to cover their costs, for the risk involved and the service they provide.
Your repayments in the future, pay back the money they created out of nothing.

The asset bought covers them if you default, they will repossess it and sell it to recover the rest of the debt unpaid.

At the end all is back to square one.

The bank has received the interest for its service.

You have paid for the asset you have bought plus the interest to the bank for its service of letting you use your own money from the future.

Today's massive debt load is all money borrowed from the future for things already bought.

It can also go wrong another way, when banks lend into asset bubbles that collapse very quickly. The repossessed asset doesn't cover the outstanding debt and money gets destroyed on the banks balance sheets.

When banks lend in large amounts, on margin, into stock markets, the bust shreds their balance sheets (1929).

When banks lend in large amounts on mortgages into housing markets, the bust shreds their balance sheets (2008).

If banks don't lend prudently you are in trouble.

Then they developed securitisation …… oh dear (no need to lend prudently now).

Housing booms and busts around the world …… oh dear.

All that money borrowed from the future and already spent …… oh dear.

susan the other , April 16, 2016 at 12:16 pm

This is so interesting. It seems to be approaching the subject that Wray speculated about a while back – that we should give central banks fiscal responsibility. Because otherwise a sovereign state has no control over its sovereign money? It seems to me that money itself becomes a rehypothecated asset by virtue of being invested over and over again – if it is well allocated and under good fiscal control all is well. If not we get the Great Recession.

So let the state become the defacto shadow central bank so it had direct control of its own money. Instead of hanging on to the old gold standard mindset of top down management, why not think of people, not collateral, as the root of the system – the grass roots. How much money does a system – a sovereign country – need per person. And then establish a sovereign central bank to deal directly, bringing the shadows into the sunlight of fiscal control.

JTHcPhee , April 16, 2016 at 12:35 pm

…and does anyone remember the triumph of the desk slaves of the Crimson Permanent Assurance? Monty Python understood something about political economies and how one might achieve more fairness in outcomes… https://vimeo.com/111458975

Paul Tioxon , April 16, 2016 at 12:38 pm

Moneyness, like doggitas, you just can't scratch behind its ears. If shadow money is distinguished by its relationship to collateral, as opposed to money issued by the state, with the entire human enterprise of civilization as its basis, it still seems to me that at the top of the money hierarchy is fiat money, the real money by the real social order empowered by the social forms of power that sustain human life in all of its aspects, not just the financial conveniences. Shadow money sounds to me like fictional capital by another name. And contractual based deposits sounds like counterfeiting. With the distinction that the man with counterfeit printing press robs the train, while the man who runs the Wall St Investment bank repo trading desk robs the whole railroad. Am I right or Am I right. What a bunch of Losers!!!

And if there is any doubt about the fictional quality of $Trillions and $ Trillions of dollars, physicists can not find anything naturally occurring in the universe beyond billions and billions. Money, simply a numbered record, a counting or cardinal number, transforms into money in name only, MINO, when it refers to fictional amount that can only appear contractually as words, and do not count how much economic activity or output has been produced.

Therefore, Money becomes a victim of the ontological argument for God by St Anselm. If God does not exist, an all powerful, all knowing, all present infinitely great in all categories of Supreme Being could not be written or spoken about, lacking the quality of existence. The fact that we CAN speak about an Omnipotent Supreme Deity means that one in fact exists, due to existence is part and parcel of Omnipotence. But of course, because we can talk or write about something, does not make it real.

It can become socially acceptable as in the case of shadow money, but it is fictional capital, a shadow of the real thing. Time to get out of the cave of finance with its shadows dancing from the light of the fires and walk eyes wide open in the bright light of sunshine!

craazyman , April 16, 2016 at 12:43 pm

I don't know about this one. It seems to me to be some pretty queasy thinking. It kind of wanders around in circles of confusion. "my existence led by confusion boats, mutiny from stern to bow".

That's pretty funny somebody would say that money is diabolically hard to write about. That's pretty funny.

Money is actually the easiest thing to write about, because it's formless energy. It's not that the phenomenon is shadow money, it's shadow assets.

You have to be able to separate in your mind the ideas of 1) Quantity and 2) Form. That's why economics is a mental disorder, because it doesn't separate quantity and form. If you can't or don't, then yes, it's diabolically hard to write about because you're writing about two different things simultaneously without realizing it. Money is a quantity that is infinite and continuous, but form is an idea that is discontinuous and finite. People do what the forms tell them to do. The money is just like electricity that powers the animation of the forms. Repo is a form it's not money. It's existence results in a certain ordering of social relations, that's also a form. But money is just the energy that makes the forms potent.

The primary challenge is to come up with an ordered way of thinking about the forms themselves. That's frankly not easy. The ideal would be to understand them in the manner in which Euclid understood geometrical ideas. If you can get the vision, then you can see all the possibilities for structure and ordered relationships. there's really no triangle in reality and there's no point and there's no line and there's no plane. They just made them up to approximate physical reality. Then they thought to themselves "Holy shit! These ideas interrelated in an astounding range of symmetries and causations." Then they became a lens or a framework through which physical reality was interpreted. But they didn't confuse the idea of "number" with the idea of "triangle" or "circle".

Certainly in math the algebraic interpretation doesn't rely completely on the geometrical interpretation. But if there is no geometrical interpretation and it's only algebra, then so much is missing, so much is lost. I guess that's why they used to call it "political economy" before the mental disorder fully usurped the power of perception and reasoning.

susan the other , April 16, 2016 at 2:18 pm

lovely to read you

Watt4Bob , April 17, 2016 at 8:58 am

Certainly in math the algebraic interpretation doesn't rely completely on the geometrical interpretation. But if there is no geometrical interpretation and it's only algebra, then so much is missing, so much is lost.

With that firmly in mind, I think it's necessary to mention the fact that the " study " of "economics" relies on calculus, wherein we are introduced to the notion of change over time, volume, motion, acceleration, rates of change, vectors, etc.

Algebra and geometry are, as you point out, obvious abstractions, but once you add volume motion, and rates of change, the models become very seductive, and it's easy to see how one can be convinced that they are approaching an understanding of 'reality'.

The trouble is of course, that the egg-heads busy trying to describe economic "reality" with calculus, are, for the most part in the employ of savages who will forever cling to a simple arithmetic where their only interest is in "having it all".

Genius employed to make excuses for demented indifference.

Jim Haygood , April 16, 2016 at 1:27 pm

'Central banks should lend unsecured … we suggest that the state, as base-asset issuer, becomes a de facto shadow central bank.' - Daniela "Zsa Zsa" Gabor

This statement desperately needs Walter Bagehot's qualifications: "to solvent institutions" and "at a penalty rate."

Otherwise, we're just talking about another squalid round of "TARP for Jamie," as we peasants reach for our pitchforks.

cnchal , April 16, 2016 at 2:07 pm

Bagehot, eh.

It should however be pointed out that the idea of shadow banking is not remotely new. The concept was presaged well over a century ago by Walter Bagehot, the legendary English banker, essayist, and theorist. In 1873, Bagehot wrote Lombard Street: A Description of the Money Market, his canonical work on the money market and central banking. In it, he observed that the great London banks were accompanied by a parallel set of financial firms, known as "bill brokers," which in many ways resembled modern-day securities dealers. Like today's dealers, these bill-brokers financed themselves with borrowings that, Bagehot informs us, were "repayable at demand, or at very short notice."

Formally speaking these firms were not banks but to Bagehot they might as well be. "The London bill brokers," he observes, "do much the same [as banks]. Indeed, they are only a special sort of bankers who allow daily interest on deposits, and who for most of their money give security [i.e., collateral]. But we have no concern now with these differences of detail." At times, Bagehot is careful to note that the short-term obligations of bill-brokers were not technically deposits; he observes that the maturing of these liabilities "is not indeed a direct withdrawal of money on deposit," although "its principal effect is identical."

Other times, however, Bagehot dispenses even with this distinction: "It was also most natural that the bill-brokers should become, more or less, bankers too, and should receive money on deposit without giving any security for it." Here we have an unambiguous identification of the shadow banking phenomenon about 140 years ago .

Bas , April 16, 2016 at 1:30 pm

it's all been reduced to gambling with no meaningful value in "The House" to back it up. Money will disappear, like in Star Trek.

fresno dan , April 16, 2016 at 1:36 pm

I would posit that there are two types of money
A – money of the 0.001% – if they walk into a casino, real estate transaction, or any asset for that matter they can NOMINALLY lose money – in fact the 0.001% NEVER lose any of THEIR money, they just lose your money. All winnings, of anybody doing anything anywhere, belong to them.
B – money of everybody else – this money nominally is yours to do with as you see fit, but it ALL belongs to the 0.001%. The collateral that backs it up is everything you earn and own and when necessary your, and your family's, internal organs…

Jamie , April 16, 2016 at 4:46 pm

"The nation [England] was not a penny poorer by the bursting of these soap bubbles of nominal money capital. All these securities actually represent nothing but accumulated claims, legal titles to future production. Their money or capital value either does not represent capital at all … or is determined independently of the real capital value they represent."

– Marx
Banking Capital's Component Parts
Capital: Volume Three

James Levy , April 17, 2016 at 6:07 am

Marx failed to acknowledge that supposedly hard-headed Capitalism is actually all about living beyond your means and mortgaging the future.

It was designed from the Fuggars' and the Medici's to be about debt and fractional reserves and interest. A system based on a finite supply of money is going to grow not much faster, at best, than the money available allows.

Capitalism allows explosive growth by supplying explosive amounts of credit. All this shadow banking activity is designed to get around reserve requirements; nothing else I can see calls all this complexity into existence. The banks always need more, because lending is how they make their money, so they want an infinite amount to lend in order to drive their profits towards the infinite.

Sy Krass , April 16, 2016 at 10:41 pm

A sovereign can create its own currency, but theoretically couldn't it create any currency? Couldn't Greece for example click a few key boards put some ones and zeros in and say, "oh our account with $1,000,000 US is actually $10,000,000,000 US?

HAHAHAHAHA!!!!!!!

financial matters , April 17, 2016 at 5:49 am

This article I think defines shadow money alright as starting where bank deposits leave off but as the above comments suggest seems to miss some key points. I think a major problem with the article is seeing central banks as separate from the state rather than seeing the central bank along with the Treasury as the state itself.

The article gets Treasury debt wrong by seeing it as the central bank funding the state rather than as actually coming from the state. This leads to wrong policy choices such as this state money being used to bail out useless financial transactions and asset appreciation rather than the public purpose. I think crazyman has it right. We left behind the power of perception and reasoning by not realizing the importance of political economy.

Lambert Strether, April 17, 2016 at 7:22 am

This is reminscent of Gramsci's idea that the state and civil society are to be distinguished only for purposes of exposition.

ewmayer, April 17, 2016 at 4:45 pm

Some issues with the piece and questions for the authors (and fellow NCers):

I really wish such analyses would use the more-precise term "credit-money" in reference to money creation by banks, to distinguish it from government money creation, which similarly may have repayment requirements attached (bonds), but need not be so. The "need not be so" may occur via outright fiat emission, but more commonly appears in form of a public debt stock which continually increases with time, at least in nominal terms.

The legal right to re-use (re-hypothecate) collateral allows various (shadow) banks to issue shadow money against the same government bond, which becomes akin to a base asset with "velocity."

Fine, but what about that other crucial element of modern bank credit-money creation, leverage? Are there any practical limits on shadow banks' issuance of multiple units of shadow money against the same government-bond money unit? If so, how are they enforced (if at all)? Note also the key concept of "implied leverage" inherent in such schemes, where the leverage ratio may fluctuate drastically with the mark-to-market valuation of the collateral. Banks play endless games with "fictional reserves"; it would be naive to imagine that non-bank shadow lenders don't do similarly with their alleged collateral.

The first point, persuasively made by Perry Mehrling, and more recently by Bank of England, is that central banks need a (well-designed) framework to backstop markets, not only institutions.

Erm, markets are the *only* thing the government should be committed to ensuring functioning of - we have overwhelming evidences from multiple boom-bust-crisis episodes over the last 3 decades of the toxic results of governments backstopping hyperleveraged fraud-riddled institutions and the crooks running same.

[Mar 14, 2016] Theres Only One Buyer Keeping S P 500s Bull Market Alive

Resurgence of voodoo science is typical during crisis periods. "Deficits does not matter" voodoo does not work in a world were there are strong economic competitors to the USA and where euro and Yuan exists. The idea of deficit spending which Michelle Jamrisko discusses actually came from Keynesian economics, not from MMT.
Notable quotes:
"... Bridgewater's Ray Dalio, head of the world's biggest hedge fund, and Janus Capital's Bill Gross say policy makers are cornered and will have to resort to bigger deficits. ..."
"... "I have no problem with deficit spending," said Aneta Markowska, chief U.S. economist at Societe Generale in New York. "But this idea of the government printing money -- unlimited amounts of money -- and running unlimited, infinite deficits, that could become unhinged pretty quickly." ..."
"... Many more agree that it's precisely when households are cutting back that governments should do the opposite, to prevent a slump in demand. ..."
"... Most economists don't expect an imminent U.S. recession. But financial-market turmoil and America's political upheaval have added to a sense that nobody has figured out a cure for the economy's malaise. ..."
March 13, 2016 | Bloomberg Business

In an American election season that's turned into a bonfire of the orthodoxies, one taboo survives pretty much intact: Budget deficits are dangerous. A school of dissident economists wants to toss that one onto the flames, too.

It's a propitious time to make the case, and not just in the U.S. Whether it's negative interest rates, or

Calls for governments to take over the relief effort are growing louder. Plenty of economists have joined in, and so have top money managers. Bridgewater's Ray Dalio, head of the world's biggest hedge fund, and Janus Capital's Bill Gross say policy makers are cornered and will have to resort to bigger deficits.

"There's an acknowledgment, even in the investor community, that monetary policy is kind of running out of ammo," said Thomas Costerg, economist at Standard Chartered Bank in New York. "The focus is now shifting to fiscal policy."

Currency Monopoly

That's where it should have been all along, according to Modern Money Theory. The 20-something-year-old doctrine, on the fringes of economic thought, is getting a hearing with an unconventional take on government spending in nations with their own currency.

Such countries, the MMTers argue, face no risk of fiscal crisis. They may owe debts in, say, dollars or yen -- but they're also the monopoly creators of dollars or yen, so can always meet their obligations. For the same reason, they don't need to finance spending by collecting taxes, or even selling bonds.

The long-run implication of that approach has many economists worried.

"I have no problem with deficit spending," said Aneta Markowska, chief U.S. economist at Societe Generale in New York. "But this idea of the government printing money -- unlimited amounts of money -- and running unlimited, infinite deficits, that could become unhinged pretty quickly."

To which MMT replies: No one's saying there are no limits. Real resources can be a constraint -- how much labor is available to build that road? Taxes are an essential tool, to ensure demand for the currency and cool the economy if it overheats. But the MMTers argue there's plenty of room to spend without triggering inflation.

The U.S. did dramatically loosen the purse strings after the 2008 crisis, posting a deficit of more than 10 percent of gross domestic product the next year. That's since been trimmed to 2.6 percent of GDP, or $439 billion, last year.

... ... ...

Tighten Belts?

Those who push back sometimes argue that money-printing puts countries on a path that eventually leads, in a worst-case scenario, to Zimbabwe -- where money-printing debased the currency so badly that all the zeros could barely fit on banknotes. Or Venezuela, whose spending spree helped push inflation to 180 percent last year. Japan's a more mixed picture: years of deficits haven't scared off borrowers or unleashed inflation, but haven't produced much growth, either.

There's also a peculiarly American enthusiasm for balanced budgets, according to Jim Savage, a political science professor at the University of Virginia. He's traced it to the earliest days of the U.S., rooted in a "longstanding fear of centralized political power, going back to England."

Wray says there are episodes in American history when a different understanding prevailed. During World War II, he says, U.S. authorities learned a lesson that's since been forgotten -- that "we've always got unemployed resources, including labor, and so we can put them to work."

Savage says Americans have historically tended to conflate household and government debts. That category error is alive and well.

"Small businesses and families are tightening their belts," President Barack Obama said in 2010 as he announced a pay freeze for government workers. "Their government should, too."

It's not just MMT economists who winced at the comment. Many more agree that it's precisely when households are cutting back that governments should do the opposite, to prevent a slump in demand.

That argument doesn't carry much sway in Congress, though. That's one reason the Fed has had to shoulder so much of the burden of keeping the recovery alive, Societe Generale's Markowska says.

"When it comes to deciding on monetary easing, it's a handful of people in the room," she said. "It's going to take more pain to build that political consensus around the fiscal stimulus."

Wray says he'd expected attitudes to start shifting after the last downturn, just as the Great Depression gave rise to Keynesian economics and the New Deal, but "it really didn't change anything, as far as the policy makers go."

"I think it did change things as far as the population goes," he said, citing the anti-establishment campaigns of Sanders and Republican Donald Trump. It might take another crash to change minds, Wray says.

'Strange Period'

Most economists don't expect an imminent U.S. recession. But financial-market turmoil and America's political upheaval have added to a sense that nobody has figured out a cure for the economy's malaise.

Bill Hoagland, a Republican who's senior vice president of the Bipartisan Policy Center, has helped shape U.S. fiscal policy over four decades at the Congressional Budget Office and Senate Budget Committee.

He says a farm upbringing in Indiana helped him understand why "it's engrained in a number of Americans outside the Beltway that you equate your expenditures with your revenue." He also acknowledges that government deficits are different, and could be larger now to support demand, so long as there's balance in the longer term.

Most of all, Hoagland says he sees profound change under way. The "catastrophic event" of the 2008 crash may be reshaping American politics in a way that's only happened a handful of times before. And economic orthodoxy has taken a hit too.

"We're going through a very strange period where all economic theories are being tested," he said.

[Jan 30, 2016] How Central Banks (and Even Keynes) Misled the Public About Banking and Money

Notable quotes:
"... By Perry Mehrling, a professor of economics at Barnard College. Originally published at his website . ..."
"... Yes, the money creation process has been a big lie for a long time. In any case the Bank of England came clean a couple of years ago and admitted that standard story of money creation was false. They even acknowledge that it is not properly explained in most money and banking textbooks, which is a staggering admission. ..."
"... Paul Krugman wrote a column a couple of months ago where he claimed that banks take in savings from depositors and lend them out to borrowers which tells you either: 1) he doesnt know how banking works or 2) he is part of the conspiracy to keep the public in the dark. ..."
"... The truth right from the mouth of the worldss oldest central bank. http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf ..."
"... Yeah, I saw that. It is amazing that a supposedly foremost Princeton Nobel winning economist apparently doesnt understand where money comes from… ..."
"... There is evidence that Krugman seems to have great difficulty admitting he was wrong. ..."
"... And what he writes makes me think he doesnt know how banking works. I find it difficult to believe he is part of any conspiracy. But I may be wrong. ..."
"... My take is that the fractional reserve and intermediation models are just ways of obfuscating the way banking actually works and the credit creation model is the accurate one. I have some advice for anyone who is struggling with the concepts which is as follows: always merge all the banks in the banking system into one bank in your mind. Assuming multiple banks as the author above does is irrelevant to the analysis and only serves to add confusion. ..."
"... I enjoyed the article very much. And it does seem to me that money creation is made to seem very, very, complex. Now maybe Im just too stupid, but it always strikes me that when people simply describe something, they either really dont know, or they are trying to bamboozle you… ..."
www.nakedcapitalism.com

By Perry Mehrling, a professor of economics at Barnard College. Originally published at his website .

In his recent paper, "A Lost Century in Economics: Three Theories of banking and the conclusive evidence" , Richard Werner argues that the old "credit creation theory" of money is true (empirically "accurate"), while both the newer "fractional reserve theory" and the presently dominant "debt intermediation theory" are false. For him, this matters mainly because the false theories are guiding current bank regulation and development policy, leading down a blind alley.

But it matters also simply because we need correct understanding of how the economy actually works, "we" meaning not just economists but also the general public. "Today, the vast majority of the public is not aware that the money supply is created by banks, that banks do not lend money, and that each bank creates new money."

Why is the public ignorant of the truth? Much of Werner's paper is devoted to an account of how the correct theory was pushed out of the conversation, first in the 1930s by the fractional reserve theory, and then after WWII by the debt intermediation theory. One culprit was a shift toward deductive and away from inductive methods. Another culprit, he suggests, was the self-interested "information management" by central banks, i.e. direct suppression of truth in their own publications. And in this suppression, he further suggests, Keynesian academics were at the very least complicit: "attempts were made to obfuscate, as if authors were at times wilfully trying to confuse their audience and lead them away from the important insight that each individual bank creates new money when it extends credit."

In this history, Werner gives special attention to Keynes himself since Keynes seems to have held each of the three theories in succession throughout his life. Keynes' own intellectual trajectory thus foreshadows the subsequent evolution of monetary thought, and so probably is partly responsible for leading successive generations astray. Just so, one apparent legacy of Keynes is that the Bank of England is currently holding all three theories at the same time! "Since each theory implies very different approaches to banking policy, monetary policy and bank regulation, the Bank of England's credibility is at stake." BoE credibility is thus a third reason that all of this matters.

But is it really true, as Werner claims, that these three theories are "mutually exclusive"?

He is at considerable pains to show that they are mutually exclusive, by using a succession of stylized balance sheet examples. The credit creation theory says that banks make loans by creating deposits, essentially expanding their balance sheets on both sides by the same amount. (The borrower of course also expands his own balance sheet, the loan being his liability and the deposits being his asset. In my own "money view", I call this a swap of IOUs.) In this way, money (bank deposits) is created that was not there before.

By contrast, the debt intermediation view says that banks make loans by lending reserves that they are already holding, essentially swapping one asset for another, these reserves having previously been obtained by someone's deposit. The balance sheet expands when the deposit is made, not when the loan is made. Banks merely intermediate between savers and borrowers, and do not create money.

In between these two views, the fractional reserve view says that individual banks make loans by lending reserves, but that the banking system as a whole can and does create money, up to a multiple of reserve holdings. The banking system does create money, but only after and as a consequence of the central bank increasing reserves–this is the famous "money multiplier".

So the difference between the theories seems clear, and it also seems like that difference should be testable empirically simply by watching actual bank balance sheets and seeing what happens when a loan is made. Does the balance sheet expand or does it not? With the cooperation of an actual bank, Werner books a dummy loan and finds that the balance sheet of the bank does in fact expand. This he takes to be scientific proof that the credit creation theory is correct and the others are false.

Not so fast. Let's look a bit closer.

Let me begin by admitting my sympathy for Werner (as I have already hinted by mentioning my own "money view" as a version of the credit creation view). In fact, Werner's heroes–H.D. McLeod and Joseph Schumpeter–are my own heroes as well, and I suspect that graduate school exposure to these authors sent him off on his own intellectual journey just as it did me. Even more, thirty years after that initial exposure, I find Werner's (co-authored) money and banking textbook "Where Does Money Come From?" one of the best introductions to the subject. Last fall I assigned Chapters 2 and 4 in the first two weeks of "Economics of Money and Banking" which I teach at Barnard College, Columbia University. I'm sympathetic.

But I don't think these three theories are quite as mutually exclusive as he makes them out to be.

For me, the central analytical issue is the distinction between "payment" and "funding" .

Let us suppose, with Werner, that Citibank makes a mortgage loan to me of $200,000, simply by swapping IOUs. I then transfer my new asset (the new Citibank deposit) to you, and you transfer your house to me. As my payment clears, you have a new deposit in your own bank (let's say Chase, to make it interesting), Citibank has a "due to" at the clearinghouse, and Chase has a "due from". Again, to make it interesting, let's suppose that Citibank has no reserves, so it enters the interbank market to borrow some, from Chase. At the end of the day, what we see is that the Citibank balance sheet is still expanded, so is Chase's, and so is mine. Only your balance sheet stays the same size, since you have swapped one asset (your house) for another (money). That's the payments perspective.

What about the funding perspective? If we follow the balance sheets through, it is clear that your money holding is the ultimate source of funds for my borrowing. (You lend to Chase, which lends to Citi, which lends to me.) In this sense, we can think of both Chase and Citibank as intermediaries, channeling funds from one place in the economy to another. But, in this example, there is no saving and there is no investment. The sale of the house adds nothing to GDP, it is just a transfer of ownership. The expansion of the banking system has facilitated that transfer of ownership by creating a liability (the deposit) that you apparently prefer to your house, at the same time acquiring an equivalent asset of its own (the loan). Citibank collects the spread between the mortgage rate and the interbank rate; Chase collects the spread between the interbank rate and the deposit rate.

But all of that is only what happens right at the moment of payment. What happens afterwards depends on the further adjustment of all of these balance sheets. One way this could all work out is that Citibank packages my mortgage with others to create a mortgage backed security, and that you spend your Chase deposit to acquire a mortgage backed security (perhaps indirectly through a mutual fund that stands in the middle). In this scenario, the newly created money is newly destroyed, the balance sheets of both Citi and Chase contract back to their original size, and the end result is that you are funding my loan directly. But again, no saving and no investment, just a change in your asset allocation, away from money toward fixed income investment.

Obviously this final scenario is a limiting case on one side. The limiting case on the other side is that you (or whoever you transfer your money to) are willing to hold the newly created money balances as an asset, so you continue to fund my loan indirectly. Now when Citibank securitizes and sells, it is able to repay its interbank liability to Chase, and for simplicity let's say that Chase uses that payment to acquire a different money market asset. One way this could all work out is that a shadow bank–money market funding of capital market lending–acquires the security and uses it as collateral for wholesale money market borrowing from Chase. Again, no saving and no investment, but the new money stays in circulation and is not destroyed.

These are the limiting cases, and obviously anything in between is also possible, depending on the portfolio decisions of Citibank, Chase, and you. But in all the cases, the debt intermediation view of banking is perfectly consistent with the credit creation view of banking. One focuses on the ultimate funding, while the other focuses on the initial payment.

That said, I have to agree with Werner that the credit creation process is all too commonly left out of the story–most modern courses never even mention the payments system–and it is a real (and important) question how this came to be so. It is a further real (and important) question why the intellectual memory of how the process actually works was left to marginalized sections of academia–Werner mentions specifically the Austrians and post-Keynesians. I'm not so sure that it was a central bank plot, though I do think that the shift in academic fashion toward studying equilibrium of a system of simultaneous equations played a role in obscuring the kind of dynamic balance sheet interactions that are the essence of the story.

What I would emphasize however is not the negative but the positive. The fact of the matter is that today the credit creation view is out of the shadows, and no longer the exclusive property of the marginalized . In evidence of this, I would direct your attention to the two Bank of England papers that Werner himself cites: here and here . But I would add to that also the most recent report coming out of the Group of 30 "Fundamentals of Central Banking, Lessons from the Crisis" . On page 3 you will find the following:

"In a barter economy, there can rarely be investment without prior saving. However, in a world where a private bank's liabilities are widely accepted as a medium of exchange, banks can and do create both credit and money. They do this by making loans, or purchasing some other asset, and simply writing up both sides of their balance sheet."

That's the truth that Werner wants central banks to admit, and now it appears that they have admitted it. The next question is what difference it makes, and that's a question for next time. Already it should be clear that progress toward answering that question will require us to be more careful about issues of payment versus funding.

P.S. BTW, the title of this post [at Merhling's site, which is "Great and mighty things which thou knowest not" [?]] is taken from Jeremiah 33:3 which Werner references in a footnote to his title: "should grains of wisdom be found in this article, the author wishes to attribute them to the source of all wisdom." Werner is apparently listening to powers higher than just McLeod and Schumpeter!

tricky rick , January 29, 2016 at 10:11 am

Chris Martenson and other "tin foil" folks have been laying this out in well documented studies for over a decade.

welcome too late to the party.

John Merryman , January 29, 2016 at 10:59 am

I think another aspect that should be considered is the preservation of surplus money through government debt.

For example, Volcker is credited with curing inflation through higher interest rates, but that slowed the economy as well and so reduced the need for money. It wasn't until Reagan had increased the deficit to 200 billion in 82 that inflation seemed to come under control enough that they could lower rates.

Now one way to create higher rates is for the Fed to sell debt it bought to create the money in the first place. So what is the difference between the Fed selling debt it is holding and the Treasury issuing fresh debt, other than the Fed destroys its money and the Treasury spends it on public works, thus Keynsian pump priming.

So who buys this debt, but those wealthy enough to have surplus money. Which suggests that if there is a surplus of money in the system, causing inflation, the easiest place to remove it is from those with a surplus of money.

Now money really does function as an enormous, glorified voucher system and what is more destructive of such a system, than enormous amounts of surplus vouchers?

So given that those with lots of such excess vouchers consequently have leverage over the rest of the system, what way to better preserve this wealth, than to have the public borrow it back and pay interest, even if much of what it gets spent on doesn't produce sufficient income to pay that interest, if not actually lost?

Eventually though even the public can't afford to keep this up, so what is the alternative?

Now most people save for predictable reasons, from raising children, housing, healthcare, to retirement and funerals. So what if the government, i.e., the public, were to threaten to tax excess money back out of the system, rather than just borrow it? Necessarily people would quickly find means to invest into these future needs directly, rather than trying to save up notational value. The problem is that we don't know exactly what we will need for what, which would mean we would have to invest into community and public projects, rather than save for our own specific needs.

While this might seem onerous, consider that we currently live in a highly atomized society, that is largely mediated by that failing financial mechanism. So if we had to start functioning as a more holistic group, with more organic interactions and public spaces and commons, people might have to come out of their shells a little more and deal with lots of other social and personal issues, which might not be a bad thing.

Basically we treat money as both medium of exchange and store of value, but these are different functions, as a medium is dynamic and a store is static. For instance, in the body, blood is the medium and fat is the store. Try storing fat in the arteries and you get clogged arteries, poor circulation and high blood pressure to compensate, which is analogous to our financial issues, with a clogged banking system, poor circulation to the rest of the economy and quantitive easing to compensate.

While the brain might need more blood than the feet, it does neither any good for the feet to rot and die from lack of circulation, nor does it do the brain any good to have excess blood. Similarly we need a stronger social structure and a leaner, more efficient economic medium, in which the excess is stored as the muscle of a stronger society and a healthier environment, rather than just treating them as stores of wealth to be monetized and siphoned away.

Helmholtz Watson , January 29, 2016 at 11:06 am

Yes, the money creation process has been a big lie for a long time. In any case the Bank of England came clean a couple of years ago and admitted that standard story of money creation was false. They even acknowledge that it is not properly explained in most money and banking textbooks, which is a staggering admission.

Paul Krugman wrote a column a couple of months ago where he claimed that banks take in savings from depositors and lend them out to borrowers which tells you either: 1) he doesn't' know how banking works or 2) he is part of the conspiracy to keep the public in the dark.

The truth right from the mouth of the worlds's oldest central bank. http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf

fresno dan , January 29, 2016 at 11:20 am

Yeah, I saw that. It is amazing that a supposedly foremost Princeton Nobel winning economist apparently doesn't understand where money comes from…

jsn , January 29, 2016 at 11:46 am

In the mainstream world money is just a "veil" that obscures your view of how the divine markets work. They deliberately leave it out because it just confuses things…

No wonder no one in that world saw the GFC coming, they still all claim whocuddaknowed?

larry , January 29, 2016 at 1:37 pm

There is evidence that Krugman seems to have great difficulty admitting he was wrong. He even contends that using IS-LM is a good too for introducing students to the macroeconomy, even when they must unlearn it when they delve deeper in to the workings of the macroeconomy, and this is after Hicks himself rejected it as being an inaccurate depiction of the macroeconomy later in his life. I can't say what Krugman is thinking, but then I don't have to. I can go just by what he writes. And what he writes makes me think he doesn't know how banking works. I find it difficult to believe he is part of any conspiracy. But I may be wrong.

helmholtz watson , January 29, 2016 at 2:51 pm

Yes it's hard to believe that Krugman might not know how money/banking works but he is a very ideological guy. I happen to be sympathetic to many of his ideological views but any one who is intensely ideological is rarely a critical and independent minded thinker. Ideology is way of simplifying complex things and making your self more comfortable, and doesn't lead to knowledge. I am no expert on money and banking but I have read ten books on the subject over the last four years and numerous papers. I am pretty sure I understand it now. I think this guy Werner is right. It seems probable that there was an orchestrated campaign to obfuscate how banking and money creation work and one can imagine why that might have happened. Banking is quite literally a pyramid scheme under even the most conservative circumstances! Such a system can work and makes sense if it is prudently managed, regulated and limited in scope.

My take is that the fractional reserve and intermediation models are just ways of obfuscating the way banking actually works and the credit creation model is the accurate one. I have some advice for anyone who is struggling with the concepts which is as follows: always merge all the banks in the banking system into one bank in your mind. Assuming multiple banks as the author above does is irrelevant to the analysis and only serves to add confusion.

Christer Kamb , January 29, 2016 at 7:10 pm

Sorry Mr Watson but the swedish Riksbank is the world´s oldest central bank

fresno dan , January 29, 2016 at 11:18 am

I enjoyed the article very much. And it does seem to me that money creation is made to seem very, very, complex. Now maybe I'm just too stupid, but it always strikes me that when people simply describe something, they either really don't know, or they are trying to bamboozle you…

I think the article would have been more enlightening though if the example had been for a house that was TO BE BUILT.
Using that as an example, it seems to me that money is LOANED into existence – the person who wants the home loan has a good reputation, but the whole point of the loan is that they don't have nearly enough money to buy the house.

The carpenters and other workers don't get paid until they have done work (they loan their work to their employer), i.e., produced a house (or some portion of it). The money in the loan becomes real because a house that didn't exist now exists. There is more stuff in the world, and there is more money. And I think it explains something important – not any loan is useful. A house worth 100K that is sold for 1000K but than is foreclosed upon – somebody has to take a real loss – either the person who got the home loan, and to the extent that they can't pay the loan back, a builder or the bank takes the loss (if the foreclosed value is less than the original loan value)
So, is that correct?

Again, thanks for the article and I am looking forward to the next one!

paulmeli , January 29, 2016 at 11:23 am

Pick any year post WWII (because the data is readily accessible).

Compare the levels of federal spending and credit expansion.

Federal spending created more money every year except for the years 1998 thru 2007, where it was about even, and for 2006 and 2007 credit expansion was some 50% higher.

Then we got the mother of all credit crises.

Over that post WWII period federal spending created ~$78T while credit created ~$46T.

The common refrain is that federal taxes subtract from federal spending so it ends up being less.

Except in what universe do income taxes accrue only against income resulting from federal spending? It's nonsense and should be derided as such. It's an accounting convenience that does not reflect what is actually happening.

It may make sense for National Accounting (and to keep banksters in the drivers seat) but it makes zero sense in a rational analysis of a real-world system. That is the only way banks could be touted as the source of most of our money.

Despite an otherwise sound argument this article perpetuates the myth.

The banksters apparently have a hold on everyone, including the so-called 'good guys'.

Some justification based on the level of bank reserves or some other convoluted argument in 5,4,3,2,1 …

financial matters , January 29, 2016 at 11:31 am

Very interesting and I'm looking forward to your next installment.

I'm especially interested in the transfer of reserves from Chase to Citi and as you further point out 'Chase possibly using its reserves to acquire a different money market asset. One way this could all work out is that a shadow bank–money market funding of capital market lending–acquires the security and uses it as collateral for wholesale money market borrowing from Chase.'

This seems to be a transmission mechanism for asset appreciation as Eric Tymoigne is getting into is his excellent series:

"post 7 will start the private-bank posts) on monetary policy and the QE -asset price channel will be explained. But here is a short answer:
No bank's don't use cash to buy assets. If they deal with non-bank agents they just credit bank accounts, if banks deal with a fed account holder they debit their reserve balances to make payments.

The link works through interest rate, arbitrage, search for yield, and the fact that QE reduces the quantity of securities available in the market."

"the issue is how they would transfer the funds to make the purchase? They could buy securities if they find a fed account holder willing to sell them securities: Treasury is one, GSE is another one. Non-financial institutions no."

craazyman , January 29, 2016 at 11:31 am

All they do is talk about how the parts of the machine move - which is itself an amazing problem of conceptual collinearity - but not the phenomenon of the machine itself.

More and more you just say "Why not go to Youtube and check out a Rhianna video, rather than read another one of these essays."

Eventually maybe they'll get it. But when they study economics their whole adult life - and nothing else - it makes it hard. It's not like they're dumb or that they lack mental ability. In fact, they're all intelligent individuals who are quite capable in most areas of thinking. It's just that the conceptual language they need to use in order to perceive the phenomenon itself is a language they do not know. And so they look at reality and they try to make sense of it using the language they do know, and because words themselves and the ideas in the words catalyze perception, their limited language is not fully adequate, and they don't see or know that. What can you do? Everybody has to see it for themselves.

At any rate, you'd think by now it wouldn't be so hard. But most people aren't interested in this sort of thing so progress is really slow. Most people just go right to Youtube.

susan the other , January 29, 2016 at 12:28 pm

Adenosine triphosphate. The example several years ago in the comments, by a biologist, that it would be an extinction event for a colony of amoeba if a few of them decided to short amoeba futures and just hoard all the adenosine triphosphate – the one chemical every amoeba must have to transfer energy. Wish it had been an analogy to symbolic ADP which had usurped the real stuff and was being hoarded to make sure it maintained its value.

susan the other , January 29, 2016 at 12:32 pm

ATP

craazyman , January 29, 2016 at 1:10 pm

very nice! you have always impressed me with your thoughtful and penetrating intelligence.

(even though you go off the wacko, foo-foo, hug-the-trees cliff sometimes.)

Clive , January 29, 2016 at 2:16 pm

You assured me susan was a bona ride adjunct professor of theosophical studies at the University of Magonia. I want, nay, I demand my tuition fee, which apparently I had to pay in advance because otherwise 42 other Chinese applicants would be in line for my place, back.

craazyman , January 29, 2016 at 2:45 pm

she's a full profeser of creative analysis. she hugs trees as an adjunct profeser of foo foo philosophy

craazyboy , January 29, 2016 at 4:16 pm

Dunno why they have all these theories. It's simple. The Fed lowers interest rates, the mark to market value of bank assets go up, which greatly improves cap ratios, then banks don't need liabilities anymore. They just can make endogenous money and give it out to borrowers' banks.(it's all done electronically and fast so no one notices) All the Big Guy econ types know that.

All the rest of it is just details banks go thru just for show. Plus they can securitize and sell any assets they think may drop in value. They're smart people.

Now, the other thing all the Big Guy econ dudes always say is once us little folk figure it out, something wonderful is supposed to happen. Maybe I missed it, but what thing is that???

Maude , January 29, 2016 at 11:33 am

You forgot one piece…

Let us suppose, with Werner, that Citibank makes a mortgage loan to me of $200,000, simply by swapping IOUs. I then transfer my new asset (the new Citibank deposit) to you, and you transfer your house to me. As my payment clears, you have a new deposit in your own bank (let's say Chase, to make it interesting), Citibank has a "due to" at the clearinghouse, and Chase has a "due from". Again, to make it interesting, let's suppose that Citibank has no reserves, so it enters the interbank market to borrow some, from Chase. At the end of the day, what we see is that the Citibank balance sheet is still expanded, so is Chase's, and so is mine. Only your balance sheet stays the same size, since you have swapped one asset (your house) for another (money). That's the payments perspective.

Is the house owned free and clear? If not, the exchange eliminates that original liability/asset on someone else's balance sheet so everything is now at a net zero as far as new money circulating in the economy. Banks did not create anything new. They only exchanged one Asset/Liability for another Asset/Liability. Even if the house was paid off 20 years ago, there is no new money created from this transaction. The only way "new money" is created would be through interest paid on Treasuries, and direct deficit spending by federal government.

Mustsign topost , January 29, 2016 at 12:08 pm

debt intermediation theory is this: consumer loans -> salary -> pension funds
kleptocracy is this: privatization -> state spending -> profit

Anon , January 29, 2016 at 12:09 pm

As the commenters on the post at Prof. Mehrling's site have observed, his argument is logically flawed. He concludes: "But in all the cases, the debt intermediation view of banking is perfectly consistent with the credit creation view of banking."

The intermediation view of banking "says that banks make loans by lending reserves that they are already holding," as he explains at the beginning of his piece. In his example, the deposit that is created by the banking system funds the loan. Of course, in both case intermediation takes place but the nature of the intermediation is not comparable.

In the first case, banks have no special status in the economy. After all any of us who has a balance of $100 can lend out that balance of $100. In the second case, the only reason the bank can make the loan is because of a social norm in which the public trusts the banking system and is willing to keep its money in banks. This fact has always been a fundamental component of the credit creation theory of money - it is founded on the public's trust in the banking system. This trust allows banks to expand the money supply - at the potential expense of the public.

While I have great respect for Prof. Mehrling, it is far from clear that he has a good understanding of the credit creation view of money.

diptherio , January 29, 2016 at 12:29 pm

When I looked into the data about 5 years ago, it appeared that only a few large banks were actually operating on a credit-creation basis. Most banks (meaning your local, independent banks and credit unions) appeared to be operating on an intermediation model. Deposits are always the cheapest way to fund a loan, and for small banks, that looks like pretty much the only way they do it – iirc, loans were 60-80% of deposits in most banks. However, at JPM, BofA, etc, their loans were well over 100% of their deposits…like waaaay over. So it looked to me like just a few big players were driving endogenous money creation, while most banks actually were doing, essentially, what fractional-reserve theory says they do.

That's my understanding, but I don't claim to be an expert.

Anon , January 29, 2016 at 12:36 pm

diptherio:

Banks no longer keep their loans on balance sheet, so a simple static analysis of their balance sheet doesn't tell us much about how much credit creation they are doing. To study the degree to which banks create money you have to look at the role they play in the shadow banking system as well.

Skippy , January 29, 2016 at 6:28 pm

Too some degree… my concerns about the shadow sector vastly out weigh the traditional sector e.g. has the traditional sector become [increasingly] just a front house op to generate velocity for the shadow sector, and the latter just needs a – store of – when the economy gets a black eye.

Skippy , January 29, 2016 at 7:17 pm

Therein lies the rub e.g. some fixate on one component of a veritable galaxy of operational scope, so at this juncture on can surmise that new universes of credit are created and inserted into the multiverse to survive on their own [inhabitants luck of the draw]. Maybe theoretical physics would be a better methodology of describing credit activity's at this juncture than thermodynamics, ideology, or socio-economic-political optics…

JeffC , January 29, 2016 at 9:29 pm

There's a confusion here. Suppose a bank with reserves R and corresponding deposits X, in addition to other balance-sheet items, has

R X.

at the top of its balance sheet. It makes loan L, which creates new deposit D to obtain balance sheet

L D *
R X.

The borrower/deposit-holder transfers her deposit to another bank, so the original bank's balance sheet drops down to

L X,

while the new bank gains this on its balance sheet:

R D.

So the sequence is (1) create new deposit D and (2) transfer the deposit to the new bank. This is the money-creation model in action. It is correct.

When we imagine that reserves are being loaned instead, we are actually skipping the balance sheet marked * above. Comparing the balance sheet before and after the skipped one, we come to believe that reserves have been turned into a loan. This is incorrect. The newly created deposit is simply in a different bank. To see what is really going on, we have to consider the loan and transfer separately.

JTMcPhee , January 29, 2016 at 4:57 pm

Can anyone tell me where that $100 came from? Or the $200,000 to buy that archetypical house? We got lots of "blind philosophers feeling their part of the elephant and pronouncing its essence" but where does "wealth" originate, as opposed to money and "assets?"

cnchal , January 29, 2016 at 10:50 pm

. . . but where does "wealth" originate

(MMT – Material Meets Tool X sales) – expenses = profit or loss. If it's profit, that is wealth. If it's loss that is hell.

nothing but the truth , January 29, 2016 at 7:59 pm

"In the first case, banks have no special status in the economy. After all any of us who has a balance of $100 can lend out that balance of $100"

yes you can lend it out, but the bank is 1) at the top of collectors line 2) has backing from the FDIC. When you loan 100$ to someone, you dont have that money anymore. When you lend 100$ to the bank, you still have that money, and about 10 other people have it as well.

JTMcPhee , January 29, 2016 at 8:33 pm

I'm sure it must be obvious to brighter and more subtle folks than me, but where does that $100 that's referenced here come from?

I have an antique wood-bodied block plane (the woodworking kind) made by my great-grandfather ( except for the perfect cast iron blade and two nails). He used tools he made or bought to carve the body and chisel out the throat and make the wedge. I was offered $100 for it recently. Where does the wealth or value that my ancestor's plane, now mine by inheritance and survival, come from? Or all the other $100s that make up " the economy" that the MorgulBankers are conjuring derivatives out of?

cnchal , January 29, 2016 at 11:32 pm

. . .I was offered $100 for it recently. Where does the wealth or value that my ancestor's plane, now mine by inheritance and survival, come from?

From your ancestor's labor in creating the plane and an ongoing demand from people interested in acquiring the plane.

Where the $100 offer comes from is the perceived value of the plane compared to other planes on offer, such as for example the Chinese made crap in Home Depot.

Since it sounds like you didn't sell it for $100, you value it at a higher price. Wondrous market eh.

Helmholtz Watson , January 29, 2016 at 1:46 pm

What is truly amazing about this is that in year 2016 there is still massive confusion and ambiguity about how money and banking work. How can that be? Bizarre!

MaroonBulldog , January 29, 2016 at 6:25 pm

Q. How can that be?

A. Easily: "the false theories are guiding current bank regulation and development policy, leading down a blind alley." If correct understanding would lead to a correct regulation, then those whose interests would no be served by correct regulation will obfuscate correct understanding.

Blurtman , January 29, 2016 at 3:21 pm

Banks lend what they do not have.

MED , January 29, 2016 at 3:25 pm

For the TBTF banks, change the famous "money multiplier". up 10% per Billion

kevinearick , January 29, 2016 at 4:08 pm

Psychograpic Marketing, LSD & Mind Control

Baby yoga for kids living in the forest, who never go outside alone; the highest real mortality rate in the US; and the prototype for Family Law feeding Obamacare in the big city – does it get any dumber than that?

The psychologists are just smart enough to get the majority killed. The markets are an exercise in control, a game, and nothing more, until Little Johnny jumps off Science Building and shorts the insanity all together. Did you see that last impulse, transferring wealth to the Soros clan, now demanding another bailout?

The assumption of emotion-based decisions, lest one be a robot, is ludicrous, but that is the basis of empire marketing. The majority short-circuits itself, with the false assumptions presented by empire media broad band, the frequency it chooses to occupy, to mirror itself, and obsessive-compulsive behavior begets itself. The brain stem is a geared Archimedes Screw.

Because the body is grounded to earth, the dc side of the brain is self-obsessed, and LSD offsets the signal into the noise of the clutch, is no reason to hand your life over to a psychologist printing money. Because the predicitive subconscious exists in a feedback loop with adaptation doesn't mean that everyone is sick, stuck on an empire frequency, and mentally ill if they don't seek diagnosis. Money is not reality, except for those who choose it.

Wall Street sells mortgages with increasing duration, Madison Avenue produces crap for compliance at increasing cost, and the majority indentures future generations with bonds, until they can't. Global finance simply liquidates natural resources and moves, in planetary rotation. Relative to unincorporated farming, the land is largely fallow, but the participants have TV, cardboard and gadgets, dependent upon empire for a battery.

Net, populations vacillate between denial and depression, with growing impulses of anger, in a market for psychologists who see others as a reflection of themselves. Married people raising independent children cannot afford to be quite so stupid. And without such children, the economy can only implode, reflecting the psychologists' own self-obsession.

Do you remember that story about the natives not seeing Christopher's ship, until the shaman pointed it out, when the natives were slaughtered by war, disease and poverty?

Females can breed on equal rights for a thousand years, with males providing the technology, but they will just end up a thousand years behind the curve. Women are bred to think in linear time, and men to think in frequency, because that is what children need. One is the counterweight and the other is the cab.

The majority, focused on self, rides the counterweight to floors on one side, all dead ends, and is jealous of children exiting on the other side. The choice at the crossroad is always the same, investment or consumption. The majority is not experiencing falling living standards and increasing income inequality because some banker provided the money, an excuse, for multicultural unicorn dreaming.

Retired people generally prefer a Fred and Wilma economy, city kids generally prefer a rat race, and once separated for the purpose, the police are generally dispatched to slice and dice families into sausage to feed the former, by authorities always pleading ignorance, majority vote. Once you see those cops, promoting gang awareness, it's time to go. At empire cycle begin, you have plenty of time; now you have none.

When I began writing this, I had no idea where the focus would be, but I do have a pattern database and a linear time translator, such as it is. My wife can tell you the weather 25 years, 3 months and 10 days ago. Choose a wife that enjoys living in the moment, and a husband that enjoys an independent frequency, compliments capable of trust in an untrustworthy world.

My mind is a steel trap, my wife's is Disneyland, and we live in the feminist capital of the world, as you might suspect with an ac mind. Your perspective is your own, if you choose to have one, and we all go through phases, climbing and descending the ladder of consciousness. I am simply sharing, after decades of listening and saying not a damn word, in the empire, on the eve of WWIII.

From the perspective of legacy, which has no clue what is in those libraries, the Internet was designed to extend linear thinking, to nowhere. From the perspective of labor, the Internet was designed to demonstrate the fallacy of limiting yourself to linear thinking. Contrary to popular mythology, choice is not about the color of your tennis shoes made in China.

If it's not anonymous cash, it cannot store value, because independent children are reared beyond empire's grasp, the physical manifestation of intellectual self-obsession, which Sweden is now learning, way to late, a slave to Germany, and Austria in particular. Knowing what needs to be done and doing it are two different things. The psychologists in New Hampshire produce drug addiction, their solution is drug rehab, and Iowa is supposed to be nuts.

You didn't think Keynes sprang from nothing did you?

Skippy , January 29, 2016 at 6:30 pm

From opti to me and from me to you….

http://nautil.us/issue/7/waste/blissed_out-fish-on-prozac

ke , January 29, 2016 at 8:52 pm

Thanks. The wife likes to keep track of water. She's like a human testing machine. Best water I had was up at bay of fungi, big moose. That document on Ford's car made of hemp and plastic was pretty cool, before he was told he would be making cars out of steel, finance.

Always thought I would end up in Australia, but like the doctor thing, the critters have to destroy everything they touch.

Thank again

nothing but the truth , January 29, 2016 at 8:05 pm

keynes is describing a dollar based on gold standard.

your problem is that you refuse to see meaning in the real. you see meaning only in money. and money, now, is nothing. it is a fiction.

all these articles are symptoms of your cognitive dissonance. all your meaning is eventually money and money is eventually nothing.

and from this seems to come the idea that since money is nothing, reality can be created from nothing.

not so easy.

animalogic , January 29, 2016 at 9:35 pm

Fiat money is not a "nothing". But it can certainly become a nothing…if everyone loses belief it it.

Skippy , January 29, 2016 at 10:10 pm

How can one lose belief in each other – ?????

Darthbobber , January 30, 2016 at 12:15 am

"Contradictions, of which money is merely the palpable manifestation, are then to
be transcended by means of all kinds of artificial monetary
manipulations. It is no less clear that many revolutionary
operations with money can be carried out, in so far as an attack on
it appears only to rectify it while leaving everything else
unchanged. We then beat the sack on the donkey's back, while
aiming at the donkey. But so long as the donkey does not feel the
blows, one actually beats only the sack, not the donkey;
contrariwise, if he does feel the blows, we are beating him and not
the sack."

At the end of the day, what ultimately needs to be impacted is not the pieces of paper.
All we can ever do with those is hand people claims against future production.

And when the theory of "managing" an economy stops at the control of aggregate numbers as its only allowable tool to influence the process, it can never accomplish the objective of avoiding major crises.

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

[Jan 04, 2016] Dollar Dominance Deconstructing the Myths and Untangling the Web

Notable quotes:
"... The US empire is one of Multi-National corporations and International Trade Deals. ..."
"... Im intrigued by that assertion, especially if this comes from a more libertarian perspective and an author who actually mentions NATO. Of course corporate welfare in various forms is a key part of what is happening, but the core issue is a literal military empire, not some vague commercial facsimile of one. ..."
"... The direct imperial threats include economic warfare, as displayed by the IMF and ECB. As demonstrated in Greece, Ukraine, and before Greece Ireland. ..."
"... By 1978, US inflation had risen to 9% while inflation in the rest of the world slowed dramatically by comparison. Both the Carter administration and the Fed did everything in their power to control dollar devaluation, but it was clear by this time that without the assistance from foreign governments the dollar would not be able to survive . … Over the course of the next six years the dollar experienced a meteoric rise in value. ..."
Jan 04, 2016 | naked capitalism

washunate , January 4, 2016 at 10:43 am

The US empire is one of Multi-National corporations and International Trade Deals.

I'm intrigued by that assertion, especially if this comes from a more libertarian perspective and an author who actually mentions NATO. Of course corporate welfare in various forms is a key part of what is happening, but the core issue is a literal military empire, not some vague commercial facsimile of one. One of the most successful Big Lies in our domestic political discourse is to blame convenient corporate villains instead of the public officials who are responsible for decision-making and implementation.

This isn't the 1980s anymore. The global financial system (post Bretton Woods) collapsed somewhere there in the 1990s. Today, things are held together by direct imperial threats, not corporate board rooms.

Synoia , January 4, 2016 at 10:50 am

The direct imperial threats include economic warfare, as displayed by the IMF and ECB. As demonstrated in Greece, Ukraine, and before Greece Ireland.

Synoia , January 4, 2016 at 10:47 am

It is not dollar hegemony that rules the world, but the global financial system which gives the dollar its place of privilege.

Syllogism? What came first the chicken or the egg?

Where to begin – one could suggest the author read Chapter 1 of Wray's MMT and rewrite considering sector balances and fiat currencies, and present the different line of argument which would arise.

MyLessThanPrimeBeef , January 4, 2016 at 1:18 pm

Unless you entice, seduce, leave no other option for the workers but to borrow, at ever lower rates, thank God.

Then, you can export jobs overseas. Wait, that's how we have managed so far…that, and renting out rooms/beds/bathrooms in your apartment.

Left in Wisconsin , January 4, 2016 at 1:29 pm

"By 1978, US inflation had risen to 9% while inflation in the rest of the world slowed dramatically by comparison. Both the Carter administration and the Fed did everything in their power to control dollar devaluation, but it was clear by this time that without the assistance from foreign governments the dollar would not be able to survive ." … "Over the course of the next six years the dollar experienced a meteoric rise in value."

Maybe not central to the main argument but I found this claim (in bold) implausible.

[Dec 02, 2015] Proponents of the gold standard generally overstate the benefits of putting golden handcuffs on a central bank

pgl, December 02, 2015 at 05:48 AM

NYTimes post:
"Republicans unhappy with the Federal Reserve are circulating an idea that long ago lost currency with most economists: a gold standard….But economic historians describe this as nostalgia for a time that never was. Proponents of the gold standard generally overstate the benefits of putting golden handcuffs on a central bank, historians say, and the costs of that reduced flexibility are considerable…In 2012, the University of Chicago asked 40 leading economists whether a gold standard would improve the lives of average Americans. All 40 said no. "You can do a lot better than a gold standard," said Michael Bordo, an economist and director of the Center for Monetary and Financial History at Rutgers University. He described the political interest in the precious metal as "pretty crazy."… Economists generally regard a gold standard as a crude and outdated method of inflation control. There is nothing inherently stable about the value of gold. It fluctuates, like the value of everything else, as more is extracted from the ground and as demand waxes and wanes. The bigger problem, however, is that economic conditions are unstable. And during recessions, printing money can help revive economic activity."

Great discussion. And nice picture of William Jennings Bryan whose "Cross of Gold" speech in 1896 won him the Democratic nomination for president. This is the best expression of the progressive agenda ever.

But wait for it – our gold bug troll JohnH will later wake up drunk again to tell us how evil the FED is and how awesome the period of the gold standard was. After all trolls nothing about history and less about economics.

anne said in reply to pgl...

The reference is necessary:

http://www.nytimes.com/2015/12/02/business/economy/the-good-old-days-of-the-gold-standard-not-really-historians-say.html

December 1, 2015

The Good Old Days of the Gold Standard? Not Really, Historians Say
By BINYAMIN APPELBAUM

[Sep 05, 2015] Fed Watch: If You Ever Wondered Whose Side The Federal Reserve Is On...

"...Real median weekly earnings have grown 8.6% since 1985. Nonfarm output per hour is up 79% over that time. Yet the instant that there is even a glimmer of hope that labor might get an upper hand, the Federal Reserve looks to hold the line on wage growth. It still appears that the Fed's top priority is making sure the cards remain stacked against wage and salary earners."
.
".When you recruit from the banksters, as the Fed does, you have to expect that their interests align with the kleptocratic rentiers."
.
"...Notice that the labor share of business income has declined by 10.6% since 2000, while real after-tax corporate profits have increased by 143.5%."
Sep 05, 2015 | Economist's View
Sep 05, 2015 | economistsview.typepad.com
Tim Duy:
If You Ever Wondered Whose Side The Federal Reserve Is On..., by Tim Duy: Catching up with Richmond Federal Reserve Jeffrey Lacker's speech. His dismissal of low wage growth numbers:
Some argue there must be excessive slack in labor markets if wage rates are not accelerating. But real wages are tied to productivity growth, and productivity growth has been slow for several years now. Wage growth in real terms has at least kept pace with productivity increases over that time period, which is perfectly consistent with an economy from which labor market slack has largely dissipated.

Real wage growth is consistent with productivity, thus there is no excess slack in the labor market. If you think this is some crazy hawk-talk, think again. Fed Chair Janet Yellen in July:

The growth rate of output per hour worked in the business sector has averaged about 1‑1/4 percent per year since the recession began in late 2007 and has been essentially flat over the past year. In contrast, annual productivity gains averaged 2-3/4 percent over the decade preceding the Great Recession. I mentioned earlier the sluggish pace of wage gains in recent years, and while I do think that this is evidence of some persisting labor market slack, it also may reflect, at least in part, fairly weak productivity growth.

For more than three decades, the pace of productivity growth has exceed that of real compensation:

Another view from real median weekly earnings:

Real median weekly earnings have grown 8.6% since 1985. Nonfarm output per hour is up 79% over that time. Yet the instant that there is even a glimmer of hope that labor might get an upper hand, the Federal Reserve looks to hold the line on wage growth. It still appears that the Fed's top priority is making sure the cards remain stacked against wage and salary earners.

Posted by Mark Thoma on Saturday, September 5, 2015 at 09:48 AM in Economics, Fed Watch, Monetary Policy | Permalink Comments (52)

pgl :

Let's unpack this spin:

"But real wages are tied to productivity growth, and productivity growth has been slow for several years now."

Productivity by definition is output per worker. So when a recession lowers output, it lowers measured productivity. So much for this garbage circular "reasoning".

Oh and the canard that JohnH does a lot - look at only what has happened of late:

"Wage growth in real terms has at least kept pace with productivity increases over that time period, which is perfectly consistent with an economy from which labor market slack has largely dissipated."

Tim Duy has already exposed this fallacy by looking at this over a longer period of time.

pgl -> Paine ...

Dude - this is a whole literature on this. Recessions do lower output by more than it lowers employment but this is not exactly because firms are nice. Recessions are bad news for everyone. Wages do not keep up with what is even limited inflation - again firms are not exactly nice. So recessions sort of screw firms but unbelievably screw workers. Eventually the economy gets back to full employment but workers never fully recovery.

This is why recessions are bad for everyone in the short fun but especially bad for workers short-run and long-run.

Which brings me to why I did not go after Yellen. It seems she and hubbie Akerlof have written some of the best papers on this topic.

Paine - stop being an arrogant lazy ass and actually check up on this literature.

Now if your point is that the FED borg (I coined this term) is about to take over Yellen's mind, I fear this too. It seems to have taken over Stan Fischer's mind and he used to be brilliant.

ilsm -> Paine ...

The fed hawks are like pentagon version hawks since 1946.....

we cannot have any more pearl harbors

or inflation......

DrDick :

DrDick :

When you recruit from the banksters, as the Fed does, you have to expect that their interests align with the kleptocratic rentiers.

mrrunangun :

Domestic US wage rates have been flat. In the graph, the lines cross between 1975 and 1985. During those years, international competition increased in the tradable goods sector, IMO due to the recovery of Japanese and European industrial economies from the destruction suffered in WWII. The divergence between the curves expands more rapidly as more free trade agreements come on line in the 90s (e.g. NAFTA in 1992 and PNTR for China in 1999).

It may be that intensifying competition in the tradable goods sector has slowed wage gains in the US by a supply and demand imbalance for labor. The increasing wage premium to education over the past 40 years and the capture of the domestic political system, and thus capture of the government, by the very rich, has made it impossible for the political system to make adjustments to the change in international competition that would benefit the unskilled or semiskilled worker.

Mike Sparrow -> mrrunangun...

The trade agreements are vastly overrated in terms of competition and instead, they are what help surge productivity. The US began to have offshoring in the 1950's, especially after the Korean war era boom. Companies began to bail as the US had developed a consumer base. This is very typical of capitalism. It happened in Europe in the 19th century because of the same reason.

Keeping a strong consumer base and industrial base would liquidate capitalist positions and turn the economy into laborism.

Mike Sparrow :

I would argue productivity is too high, still. Real productivity really zoomed from the mid-90's and really never came back down. The late 00's recession made it worse.

Persistently high productivity causes real wages to struggle to keep up. I think many hobbyists have it backwards with wages including myself. Yes, real wages rose rapidly between 1997-2000, but that was only because productivity surged. The long run problem of that was wage stagnation due to the previous high productivity, which has been there since the 80's. Real wage acceleration coupled with correcting productivity is a good sign and the Fed doesn't like it because they want high productivity all the time.

The Rage -> Peter K....

I think what he is trying to say, reading through his posts: technology is driving down the need for labor investment and the information/computer/plastic/whatever you want to call it revolution really drove that point home to the end.

So productivity is high, creating profits from reduced pace of hiring and keeping pipelines of credit open for future output. However, productivity is slowing lately and real wages have accelerated implicating that near term output will be higher than while future output will be lower. Yeah, that part is a bit confusing, but the drift is that productivity/real wages need to track together closer or you get problems. When they come unglued, the offender, this case productivity, needs to come down for wages to catch up. Real wages were to high before 1980 and productivity should run a bit higher than wages. So by 1995, the problems that helped spur the great inflation had ebbed, but a new problem started: rapid productivity growth.

I read this in 2009 believe it or not in a article. Their belief was if productivity stayed high and growing, the economy would be in permanent recession. They believed to maintain stability, productivity had to decline for the next decade. Mercy, I wish I could remember where I read that from. 6+ years leaves a large gap. I do think the chart shows the "panic" over slowed productivity is pure noise. Between 95-00 it when "boom boom". Notice the pre-95 trend and the post-95 trend. To the productivity must decline squad, a decline in productivity will help real wages rise boosting real incomes and reducing nominal debt, creating a more stable economy.

Dickeylee :

We are still in a slave labor economy. The whole world is looking for the next labor market to enslave. Nike in Vietnam, Apple in China, and China looks poised to take over Africa.

If you can't get your slaves shipped to you, go to your slaves!

pgl -> Dickeylee...

China looks poised to take over Africa? I guess the Chinese capitalists hate paying $3 an hour and so will pay Africans less. If you check - multinationals are in Africa and they are mainly US and European based companies. It seems we beat the Chinese to this.

ilsm -> pgl...

Pentagon deploying to keep the peace in Africa for the job creators........

Lafayette -> pgl...

PITY AFRICA

The plight of Africa is that it has been plundered by both Europe and America over the past two centuries. By America principally for cheap labor brought over on slave-ships.

Do not overlook the fact that damn few African countries can seem to develop a leadership that does not plunder its country's assets for their own personal profit.

This plague of profiteering has existed since time immemorial and China is just the newest entrant to the game ...

DrDick -> pgl...

China has been making significant inroads there for over a decade and are currently the largest single player there.

http://www.businessinsider.com/why-china-has-become-so-big-in-africa-2015-1

pgl -> Dickeylee...

Your comment actually has some merit in two senses. China has recognized that its habit of investing in government bonds of other nations (e.g. US) is giving them a lower return than what foreign direct investment offers. And Africa is attracting a lot of foreign direct investment. I went searching for who the big players are and this gave an interesting list:

http://theafricachannel.com/5-multinational-corporations-making-significant-investments-in-africa/

But it shows the BRIC nations (C for China) has been doing FDI in Africa for a while.

If multinationals are going global, maybe the labor movement should do the same. Workers of the world unite!

Julio :

Rasputin explained why the Fed must raise rates before the next recession, so it can lower them later:

"Certainly our Savior and Holy Fathers have denounced sin, since it is the work of the Evil One.
But how can you drive out evil except by sincere repentance?
And how can you sincerely repent if you have not sinned?"

anne :

https://research.stlouisfed.org/fred2/graph/?g=1Jpv

January 30, 2015

Labor Share of Nonfarm Business Income and Real After-Tax Corporate
Profits Per Employee, 2000-2015

(Respectively indexed to 2000 and 2014)


Decline in labor share index:

100 - 89.4 = 10.6%


Increase in real dollar profits per employee:

15,139 - 6,218 = 8,921

8,921 / 6,218 = 143.5%

anne -> anne...

Notice that the labor share of business income has declined by 10.6% since 2000, while real after-tax corporate profits have increased by 143.5%.

[Sep 05, 2015] RE: Inflation, the Fed, and the Big Picture (Links for 09-04-15)

"...Much of Macro is still operating under the Friedman myth of Monetary policy domination. Monetary policy can have strong effects, but at other time Fiscal and Regulatory Policy are much stronger and needed for the best economic outcomes.
.
A problem with the US Fed is limited powers to set monetary and regulatory policy and it can be totally uncoordinated from fiscal and regulatory policy that are under control of Congress and the Executive. In the mid 1990s, the Fed and Clinton administration were using the same playbook and cajoled a reluctant Congress. Do the Fed an Executive even try to coordinate policy now? This Congress is the anti-Fed and operates on a playbook from the gamma quadrant. Total lack of policy coordination "
.
"...1) Real asset prices have gone up a lot as a result of QE. Now they are headed down as QE is done with no real hope of another round.
2) Nominal and Real GDP are on the way up.
3) Inflation will be the last to respond. Waiting for inflation to show up is a mistake.
4) That still does not tell us the timing of getting off the zero bound. As I have said before, the Fed has let asset prices go up too much (much has been said including Shiller's recent analysis).
The stock prices are now coming down. The fact that Netflix (which has zero exposure to China) is down 25% should give pause to anyone who believes parts of the market are not in a bubble. Add to that crashing commodity prices and growth overseas in important economies. I think the Fed needs to wait and see how it shakes out. It = asset prices, commodity prices, EM growth and finally, how all this impacts US growth."
September 04, 2015 | Economist's View

RC AKA Darryl, Ron said...

RE: Inflation, the Fed, and the Big Picture

[Actually Carmen Reinhart deserves a better pitchman here than the little comment pgl posted above. Carmen presents a expressly well written and concise picture. Since it is international then the same focus on core CPI that we get for domestic inflation is not referenced nor implied. She includes commodities in the inflation. The full text following the short excerpt given by pgl is below:]


https://www.project-syndicate.org/commentary/jackson-hole-banking-conference-inflation-by-carmen-reinhart-2015-09

...
Most of the other half are not doing badly, either. In the period following the oil shocks of the 1970s until the early 1980s, almost two-thirds of the countries recorded inflation rates above 10%. According to the latest data, which runs through July or August for most countries, there are "only" 14 cases of high inflation (the red line in the figure). Venezuela (which has not published official inflation statistics this year) and Argentina (which has not released reliable inflation data for several years) figure prominently in this group. Iran, Russia, Syria, Ukraine, and a handful of African countries comprise the rest.

The share of countries recording outright deflation in consumer prices (the green line) is higher in 2015 than that of countries experiencing double-digit inflation (7% of the total). Whatever nasty surprises may lurk in the future, the global inflation environment is the tamest since the early 1960s.

Indeed, the risk for the world economy is actually tilted toward deflation for the 23 advanced economies in the sample, even eight years after the onset of the global financial crisis. For this group, the median inflation rate is 0.2% – the lowest since 1933. The only advanced economy with an inflation rate above 2% is Iceland (where the latest 12-month reading is 2.2%).

While we do not know what might have happened were policies different, one can easily imagine that, absent quantitative easing in the United States, Europe, and Japan, those economies would have been mired in a deflationary post-crisis landscape akin to that of the 1930s. Early in that terrible decade, deflation became a reality for nearly all countries and for all of the advanced economies. In the last two years, at least six of the advanced economies – and as many as eight – have been coping with deflation.

Falling prices mean a rise in the real value of existing debts and an increase in the debt-service burden, owing to higher real interest rates. As a result, defaults, bankruptcies, and economic decline become more likely, putting further downward pressures on prices.

Irving Fisher's prescient warning in 1933 about such a debt-deflation spiral resonates strongly today, given that public and private debt levels are at or near historic highs in many countries. Especially instructive is the 2.2% price decline in Greece for the 12 months ending in July – the most severe example of ongoing deflation in the advanced countries and counterproductive to an orderly solution to the country's problems.

Median inflation rates for emerging-market and developing economies, which were in double digits through the mid-1990s, are now around 2.5% and falling. The sharp declines in oil and commodity prices during the latest supercycle have helped mitigate inflationary pressures, while the generalized slowdown in economic activity in the emerging world may have contributed as well.

But it is too early to conclude that inflation is a problem of the past, because other external factors are working in the opposite direction. As Rodrigo Vergara, Governor of the Central Bank of Chile, observed in his prepared remarks at Jackson Hole, large currency depreciations in many emerging markets (most notably some oil and commodity producers) since the spring of 2013 have been associated with a rise in inflationary pressures in the face of wider output gaps.

The analysis presented by Gita Gopinath, which establishes a connection between the price pass-through to prices from exchange-rate changes and the currency in which trade is invoiced, speaks plainly to this issue. Given that most emerging-market countries' trade is conducted in dollars, currency depreciation should push up import prices almost one for one.

At the end of the day, the US Federal Reserve will base its interest-rate decisions primarily on domestic considerations. While there is more than the usual degree of uncertainty regarding the magnitude of America's output gap since the financial crisis, there is comparatively less ambiguity now that domestic inflation is subdued. The rest of the world shares that benign inflation environment.

As the Fed prepares for its September meeting, its policymakers would do well not to ignore what was overlooked in Jackson Hole: the need to place domestic trends in global and historical context. For now, such a perspective favors policy gradualism.
Friday, September 04, 2015 at 02:44 AM

bakho said in reply to RC AKA Darryl, Ron...
Here conclusion was weak with a vague take home message.

Much of Macro is still operating under the Friedman myth of Monetary policy domination.

Monetary policy can have strong effects, but at other time Fiscal and Regulatory Policy are much stronger and needed for the best economic outcomes.
A problem with the US Fed is limited powers to set monetary and regulatory policy and it can be totally uncoordinated from fiscal and regulatory policy that are under control of Congress and the Executive. In the mid 1990s, the Fed and Clinton administration were using the same playbook and cajoled a reluctant Congress. Do the Fed an Executive even try to coordinate policy now? This Congress is the anti-Fed and operates on a playbook from the gamma quadrant. Total lack of policy coordination

pgl said in reply to bakho...
My take was that she was advocating more aggressive aggregate demand stimulus in general. And you are right - we need the fiscal side to step up to the plate.

Story in NYC as how bad just the subway stops are. The rails suck as well and we need to expand the system. But at the rate this is going this decaying stops which are very dangerous will not be fixed until 2065. Why? Lack of funding is the stated reason. No one in this stupid nation can say - well provide more funding? We are ruled by idiots.

RC AKA Darryl, Ron said in reply to bakho...
[Well, yeah but that would have diverged a long way from her topic:]

"Inflation – its causes and its connection to monetary policy and financial crises – was the theme of this year's international conference of central bankers and academics in Jackson Hole, Wyoming. But, while policymakers' desire to be prepared for potential future risks to price stability is understandable, they did not place these concerns in the context of recent inflation developments at the global level – or within historical perspective..."

[She stuck with just inflation and monetary policy because that is what she chose to write about at this time. However, Carmen is the other intellectual half of Rogoff of the debt limit for economic growth flameout. So, we should not depend upon her for fiscal policy recommendations. That even someone this popular with the establishment Republican elite can understand monetary policy is notable in contrast to the inflationistas.

Peter K. said in reply to RC AKA Darryl, Ron...
Yes she did the 90 percent government debt cutoff with Rogoff that Krugman attacked.

Also the vaguely righwing blogger from the St. Louis Fed, Andolfatto or something, recently had link where they said inflation wasn't a problem and the Fed shouldn't raise rates until inflation is apparent.

Peter K. said in reply to bakho...
"In the mid 1990s, the Fed and Clinton administration were using the same playbook and cajoled a reluctant Congress. "

I thought Clinton cut the deficit and the tech stock bubble helped balance the budget so they had surpluses. Some people say those surpluses were a problem because of a lack of safe assets. That drove money to seek safe returns in mortgage backed securities for instance.

Peter K. said in reply to Peter K....
Maybe he didn't cut the deficit - I think Dean Baker argues that - but at the beginning of his Presidency, Clinton dropped his middle class spending bill in a deal with Greenspan who said he'd keep interest rates low in return.
Peter K. said in reply to bakho...
"This Congress is the anti-Fed and operates on a playbook from the gamma quadrant."

haha yes. The Fed regularly complained about fiscal "headwinds."

Anonymous said in reply to RC AKA Darryl, Ron...
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb110301.pdf

Chart 1 is key to understanding the rough timing. In the US and UK, we are a little past the dashed vertical line (impact phase). UK has had a little more success importing inflation.

1) Real asset prices have gone up a lot as a result of QE. Now they are headed down as QE is done with no real hope of another round.
2) Nominal and Real GDP are on the way up.
3) Inflation will be the last to respond. Waiting for inflation to show up is a mistake.
4) That still does not tell us the timing of getting off the zero bound. As I have said before, the Fed has let asset prices go up too much (much has been said including Shiller's recent analysis).
The stock prices are now coming down. The fact that Netflix (which has zero exposure to China) is down 25% should give pause to anyone who believes parts of the market are not in a bubble. Add to that crashing commodity prices and growth overseas in important economies. I think the Fed needs to wait and see how it shakes out. It = asset prices, commodity prices, EM growth and finally, how all this impacts US growth.

[Sep 05, 2015] Deflation and Money

"...Friedman and Schwartz were wrong about the cause and the cure of the Great Depression. Those who learned monetarism as the "new truth" are having a difficult time unlearning it. We need re-education courses for older economists and a new curriculum for younger ones."
.
"...I don't have the neo-classical faith in the "natural" healing powers of the economy as some people do. Seems more likely that the economy would settle in to a lower equilibrium given enough fiscal austerity."
.
"...But what if the FED is a rational captain of corporate capitalism. Better then the opportunistic demagogues in the congress. But still dedicated to wage stag "
.
"..."if wage increases for the business sector as a whole lag behind productivity increases deflation occurs"..."
Sep 05, 2015 | Economist's View
The summary "Deflation and money" by Hiroshi Yoshikawa, Hideaki Aoyama, Yoshi Fujiwara, and Hiroshi Iyetomiof says:
Deflation and money, Vox EU: Deflation is a threat to the macroeconomy. Japan had suffered from deflation for more than a decade, and now, Europe is facing it. To combat deflation under the zero interest bound, the Bank of Japan and the European Central Bank have resorted to quantitative easing, or increasing the money supply. This column explores its effectiveness, through the application of novel methods to distinguish signals from noises.

The conclusion:

...all in all, the results we obtained have confirmed that aggregate prices significantly change, either upward or downward, as the level of real output changes. The correlation between aggregate prices and money, on the other hand, is not significant. The major factors affecting aggregate prices other than the level of real economic activity are the exchange rate and the prices of raw materials represented by the price of oil. Japan suffered from deflation for more than a decade beginning at the end of the last century. More recently, Europe faces a threat of deflation. Our analysis suggests that it is difficult to combat deflation only by expanding the money supply

bakho said in reply to pgl...

Monetary policy weak is at the ZLB. Fiscal and regulatory can have much stronger effects and complete swamp monetary like a tidal wave to a ripple.
Exchange rates and other economic shocks have more effect than monetary policy at the ZLB.

Friedman and Schwartz were wrong about the cause and the cure of the Great Depression. Those who learned monetarism as the "new truth" are having a difficult time unlearning it. We need re-education courses for older economists and a new curriculum for younger ones.

bakho said in reply to pgl...

Efficiency standards backed by a carbon tax would be much more effective that a carbon tax alone.
Efficiency standards work for electric appliances and prevent a races to the bottom.

pgl said in reply to bakho...

True. It seems Carly and Jeb! do not want to regulate but rather to encourage innovation by giving subsidies to rich people. Not only is this Republican reverse Robin Hoodism on steroids - it will not has as much effect as a tax combined with regulations.

Simply put - conservatives should not be listened to as their agenda is not economic efficiency but rather making the Koch Brothers ever richer.

Peter K. said...

As a thought experiment I would wonder what bakho's re-education course would look like.

There is this paper, but could it be it says the same thing as those graphs which show the large increases in the monetary base would just sit there with at the Zero Lower Bound because of the liquidity trap?

The inflationistas were wrong that all of that monetary policy would cause runaway inflation.

But considering what needed to be done to move long-term interest rates, was it really large enough?

David Beckworth's blogpost in today's links suggests the Fed did what they wanted to do.

http://macromarketmusings.blogspot.com/2015/09/revealed-preferences-fed-inflation.html

And maybe part of that was to offset the unprecedented fiscal austerity we say after Obama's stimulus ran out. (And that stimulus was pretty much canceled out by 50 little Hoovers.)

If monetary policy supposedly didn't move prices, I found it surprising that austerity didn't give us deflation as it did in Europe.

Maybe fiscal policy works better and more directly but if it is blocked or even reversed with austerity, monetary policy shouldn't be ruled because it is supposedly ineffective.

Maybe Friedman and Schwartz's maximalist claims aren't true, but that doesn't mean one should flip to the opposite extreme.

Bernanke says in a speech that Tobin suggested that the Fed could have mitigated the Great Depression by lowering long-term rates.

Peter K. said in reply to Peter K....

"What is the total number of months during the Ford, Carter, Reagan and Bush I administrations, plus the first term of Clinton, when the unemployment rate was lower than today?"

http://www.themoneyillusion.com/?p=30495

https://twitter.com/ObsoleteDogma/status/639877889979228160

Peter K. said in reply to Peter K....

"The inflationistas were wrong that all of that monetary policy would cause runaway inflation."

When confronted they always say that once the economy normalized, all of those reserves will go rushing out into the economy causing inflation.

But the Fed says it will use Interest on Excess Reserves to manage that outflow.

Peter K. said in reply to Peter K....

"If monetary policy supposedly didn't move prices, I found it surprising that austerity didn't give us deflation as it did in Europe."

I don't have the neo-classical faith in the "natural" healing powers of the economy as some people do. Seems more likely that the economy would settle in to a lower equilibrium given enough fiscal austerity.

Paine said in reply to Peter K....

Very agreeably presented

But what if the FED is a rational captain of corporate capitalism. Better then the opportunistic demagogues in the congress. But still dedicated to wage stag

Egmont Kakarot-Handtke said...

Deflation? Uupps, price theory, too, is wrong
Comment on 'Deflation and Money'

The current economic situation is a clear refutation of both commonplace employment and quantity theory. The core of the unemployment/deflation problem is that the price mechanism does not work as standard economics claims.

The correct formula for the market clearing price in the simplified consumption good industry is given here
https://commons.wikimedia.org/wiki/File:AXEC41.png

Roughly, the formula says that the consumer price index declines if (i) the average expenditure ratio falls, (ii) the wage rate falls, (iii) the productivity increases, and (iv) the employment in the investment good industry shrinks relative to the employment in the consumption goods industry. The formula follows from (2014, Sec. 5).

The more differentiated and therefore better testable formula is given here
https://commons.wikimedia.org/wiki/File:AXEC39.png

The crucial message is that the wage rate is the numéraire of the price system. If at all, the quantity of money plays an indirect role via the expenditure ratio and the employment relation of the investment good and the consumption good industry.

The rule of thumb says: if wage increases for the business sector as a whole lag behind productivity increases deflation occurs (the rest of the formula kept constant).

For the rectification of the naive quantity theory see (2011) (I)/(II).

Egmont Kakarot-Handtke

References
Kakarot-Handtke, E. (2011). Reconstructing the Quantity Theory (I). SSRN Working Paper Series, 1895268: 1–28. URL http://ssrn.com/abstract=1895268.
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2489792.

Patrick said in reply to Egmont Kakarot-Handtke...

"if wage increases for the business sector as a whole lag behind productivity increases deflation occurs"

That certainly has the ring of truth to it.

The paradox of productivity?

Jason Smith said...

The relationship between money and prices is more complicated than a simple linear relationship can capture:

http://informationtransfereconomics.blogspot.com/2015/03/japan-inflation-update.html

spencer said...

Despite deflation in Japan, over the last five years real per capita GDP growth has been greater than in the US.

Of course you have to be careful of these types of comparisons when the Japanese population is actually falling.

anne said in reply to spencer...

https://research.stlouisfed.org/fred2/graph/?g=1LK4

August 4, 2014

Real per capita Gross Domestic Product for United States and Japan, 2010-2014

(Indexed to 2010)

[ These last 5 years real per capita GDP has increased by 5.6% in the United States and 3.6% in Japan. ]

Peter K. said in reply to spencer...

Good point. This is why I am skeptical when I read people claim that Japan's extraordinary monetary policy has had no effect.

And even if Japan has done more than before courtesy of Abe and Yoda Kuroda, they also mitigate it with contractionary policy like by raising consumption taxes.

[Jul 30, 2015] How A Pork Bellies Trader And Milton Friedman Created The Greatest Trading Casino In World History

"...In stumbling to this outcome, Nixon's advisors were strikingly oblivious to the monetary disorder they were unleashing. The passivity of the "religious floaters" club in the White House was owing to their reflexive adherence to the profoundly erroneous monetarist doctrines of Milton Friedman."
.
"...The four decades since Camp David also show that the Friedmanite régime of floating money is dynamically unstable. Each business cycle recovery since 1971 has amplified the ratio of credit to income in the system, causing the daisy chains of debt upon debt to become ever more distended and fragile."
.
"..."It is ludicrous to think that foreign exchange can be entrusted to a bunch of pork belly crapshooters,""
.
"..."When currency exchange rates were firmly fixed and some or all of the main ones were redeemable in a defined weight of gold", With, then as now, less than an ounce of gold per person on Earth, a third grader had arithmetic skills enough to know this was a ridiculous claim."
economistsview.typepad.com
Jul 21, 2015 | Zero Hedge

"I held in my hand the Holy Grail for the Chicago Mercantile Exchange. The most influential economic mind of the twentieth century provided the CME with the intellectual foundation upon which to build its financial superstructure."

Nixon's estimable free market advisors who gathered at the Camp David weekend were to an astonishing degree clueless as to the consequences of their recommendation to close the gold window and float the dollar. In their wildest imaginations they did not foresee that this would unhinge the monetary and financial nervous system of capitalism. They had no premonition at all that it would pave the way for a forty-year storm of financialization and a debt-besotted symbiosis between central bankers possessed by delusions of grandeur and private gamblers intoxicated with visions of delirious wealth.

In fact, when Nixon announced on August 15, 1971, that the dollar was no longer convertible to gold at $35 per ounce, his advisors had barely a scratch pad's worth of ideas as to what should come next.

Its first attempted solution was a Burns-Connally hybrid known as the Smithsonian Agreement of December 1971. The United States needed precisely a $13 billion favorable swing in its balance of trade. This was not to be achieved the honest way-by domestic belt tightening and thereby a reduction of swollen US imports that were being funded by borrowing from foreigners. Instead, America's trading partners were to revalue their currencies upward by about 15 percent against the dollar.

Connally's blatant mercantilist offensive was cut short in late November 1971, however, when the initially jubilant stock market started heading rapidly south on fears that a global trade war was in the offing.

As it turned out, a few weeks later Connally's protectionist gauntlet ended in an amicable paint-by-the-numbers exercise in diplomatic pettifoggery. The United States agreed to drop the 10 percent import surtax and raise the price of gold by 9 percent to $38 per ounce.

Quite simply, the United States had made no commitment whatsoever to redeem paper dollars for gold at the new $38 price or to defend the gold parity in any other manner. At bottom, the Smithsonian Agreement attempted the futile task of perpetuating the Bretton Woods gold exchange standard without any role for gold.

During the next eight months, further international negotiations attempted to rescue the Smithsonian Agreement with more baling wire and bubble gum. But the die was already cast and the monetary oxymoron which had prevailed in the interim, a gold standard system without monetary gold, was officially dropped in favor of pure floating currencies in March 1973.

Now, for the first time in modern history, all of the world's major nations would operate their economies on the basis of what old-fashioned economists called "fiduciary money." In practical terms, it amounted to a promise that currencies would retain as much, or as little, purchasing power as central bankers determined to be expedient.

In stumbling to this outcome, Nixon's advisors were strikingly oblivious to the monetary disorder they were unleashing. The passivity of the "religious floaters" club in the White House was owing to their reflexive adherence to the profoundly erroneous monetarist doctrines of Milton Friedman.

A Friedmanite Fed would keep the money growth dial set strictly at 3 percent, year in and year out, ever steady as she goes.

Friedman's pre-1971 writings nowhere give an account of the massive hedging industry that would flourish under a régime of floating paper money. This omission occurred for good reason: Friedman didn't think there would be much volatility to hedge if his Chicago-trained central bankers stuck to the monetarist rulebook.

Most certainly, Friedman did not see that an unshackled central bank would eventually transform his beloved free markets into gambling halls and venues of uneconomic speculative finance.

It thus happened that Leo Melamed, a small-time pork-belly (i.e., bacon) trader who kept his modest office near the Chicago Mercantile Exchange trading floor stocked with generous supplies of Tums and Camels, found his opening and hired Professor Friedman.

THE PORK-BELLY PITS: WHERE THE AGE OF SPECULATIVE FINANCE STARTED

Leo Melamed was the genius founder of the financial futures market and presided over its explosive growth on the Chicago "Merc" during the last three decades of the twentieth century.

At the time of the Camp David weekend that changed the world, the Chicago Merc was still a backwater outpost of the farm commodity futures business.

The next chapters in the tale of Melamed and the Merc are downright astonishing. In 1970, Melamed made an intensive inquiry into currency and other financial markets about which he knew very little, in a desperate search for something to replace the Merc's rapidly dwindling eggs contract. The latter was the core of its legacy business and was then perhaps $50 million per year in annual turnover.

Four decades later, Leo Melamed's study program had mushroomed into a vast menu of futures and options contracts-covering currencies, commodities, fixed-income, and equities, which trade twenty-four hours per day on immense computerized platforms. The entire annual volume of the old eggs contract is now exceeded in literally the blink of an eye.

The reason futures contracts on D-marks and T-bills took off like rocket ships is that the fundamental nature of money and finance was turned upside down at Camp David. In effect, Professor Friedman's floating money contraption created a massive market for hedging that did not have any reason for existence in the gold standard world of Bretton Woods, and most especially under its more robust pre-1914 antecedents.

When currency exchange rates were firmly fixed and some or all of the main ones were redeemable in a defined weight of gold, exporters and importers had no need to hedge future purchases or deliveries denominated in foreign currencies. The spot and forward exchange rates, save for technical differentials, were always the same.

Even more importantly, the newly emergent need of corporations and investors to hedge against currency and interest rate risk caused other fateful developments in financial markets; namely, the accumulation of capital and trading resources by firms which became specialized in the intermediation of financial hedges. Purely an artifact of an unstable monetary régime, this new industry resulted in prodigious and wasteful consumption of capital, technology, and labor resources.

The four decades since Camp David also show that the Friedmanite régime of floating money is dynamically unstable. Each business cycle recovery since 1971 has amplified the ratio of credit to income in the system, causing the daisy chains of debt upon debt to become ever more distended and fragile.

Currently, the daily volume of foreign exchange hedging activity in global futures and options markets, for example, is estimated at $4 trillion, compared to daily merchandise trade of only $40 billion. This 100:1 ratio of hedging volume to the underlying activity rate does not exist because the currency managers at exporters like Toyota re-trade their hedges over and over all day; that is, every fourteen minutes.

Due to the dead-weight losses to society from this massive churning, the hedging casinos are a profound deformation of capitalism, not its crowning innovation. They consume vast resources without adding to society's output or wealth, and flush income and net worth to the very top rungs of the economic ladder-rarefied redoubts of opulence which are currently occupied by the most aggressive and adept speculators. The talented Leo Melamed thus did not spend forty years doing God's work, as he believed. He was just an adroit gambler in the devil's financial workshop-the great hedging venues-necessitated by Professor Friedman's contraption of floating, untethered money.

THE LUNCH AT THE WALDORF-ASTORIA THAT OPENED THE FUTURES

According to Melamed's later telling, by 1970 he had "become a committed and ardent disciple in the army that was forming around Milton Friedman's ideas. He had become our hero, our teacher, our mentor."

Thus inspired, Melamed sought to establish a short position against the pound, but after visiting all of the great Loop banks in Chicago he soon discovered they weren't much interested in pure speculators: "if you didn't have any commercial reasons, the banks weren't likely to be very helpful."

The banking system was not in the business of financing currency speculators, and for good reason. In a fixed exchange rate régime the currency departments of the great international banks were purely service operations which deployed no capital and conducted their operations out of hushed dealing rooms, not noisy cavernous trading floors. The foreign currency business was no different than trusts and estates. Even Melamed had wondered at the time whether "foreign currency instruments could succeed" within the strictures designed for soybeans and eggs, and pretended to answer his own question: "Perhaps there was some fundamental economic reason why no one had before successfully applied financial instruments to futures."

In point of fact, yes, there was a huge reason and it suggests that while Melamed might have audited Milton Friedman's course, he had evidently not actually passed it. There were no currency futures contracts because there was no opportunity for speculative profit in forward exchange transactions as long as the fixed-rate monetary régime remained reasonably stable.

Indeed, this reality was evident in a rebuke from an unnamed New York banker which Melamed recalled having received in response to his entreaties shortly before the Smithsonian Agreement was announced. "It is ludicrous to think that foreign exchange can be entrusted to a bunch of pork belly crapshooters," the banker had allegedly sniffed.

Whether apocryphal or not, this anecdote captures the essence of what happened at Camp David in August 1971. There a motley crew of economic nationalists, Friedman acolytes, and political cynics supinely embraced Richard Nixon's monetary madness. In so doing, they opened the financial system to a forty-year swarm of "crapshooters" who eventually engulfed capitalism itself in endless waves of speculation and fevered gambling, activities which redistributed the income upward but did not expand the economic pie.

As it happened, Melamed did not waste any time getting an audience with the wizard behind the White House screen. At a luncheon meeting with Professor Friedman at the New York Waldorf-Astoria on November 13, 1971, which Melamed later described as his "moment of truth," he laid out his case.

After asking Friedman "not to laugh," Melamed described his scheme: "I held my breath as I put forth the idea of a futures market in foreign currency. The great man did not hesitate."

"It's a wonderful idea," Friedman told him. "You must do it!"

Melamed then suggested that his colleagues in the pork-belly pits might be more reassured about the venture if Friedman would put his endorsement in writing. At that, Friedman famously replied, "You know I am a capitalist?"

He was apparently a pretty timid capitalist, however. In consideration of the aforementioned $7,500, Melamed got an eleven-page paper that launched the greatest trading casino in world history. It made Melamed extremely wealthy and also millionaires out of countless other recycled eggs and bacon traders that Friedman never even met.

Modestly entitled "The Need for a Futures Market in Currencies," the paper today reads like so much free market eyewash. But back then it played a decisive role in conveying Friedman's imprimatur.

In describing the paper's impact, Melamed did not spare the superlatives: "I held in my hand the Holy Grail for the Chicago Mercantile Exchange. The most influential economic mind of the twentieth century provided the CME with the intellectual foundation upon which to build its financial superstructure."

*****

Source: The Great Deformation by David Stockman

falak pema

Hahaha, for the FIRST time I see a post here on ZH where the "profoundly erroneous monetarist doctrine" of Milton Friedman gets blamed for what follows : the greatest monetary sin of the West (after the gold exchange standard according to Jacques Rueff).

The Friedmanite floating rate regime is what started the instability in the world monetary casino and yes the futures market did the rest.

Yipeeee, we have it right there. The monetary SIN laid out here at ZH and it had NOTHING to do with Keynesian plays. The Casino was a PURE product of the CHICAGO school so dear to Hayek. Who approved the supply side "liberalisation" of Reaganomics that followed.

ZH has vindicated that very important piece of the puzzle in the global financial time line of our present age.

Now Keynes's ghost can rest in piece. Monetarism will have to carry its own Cross on its Golgothan march.


The Delicate Genius

I think there may be a middle you're excluding...

falak pema

May be a middle called Nixonian petrodollar anchoring. But that did not change the Casino mantra. It just anchored "our money your problem" to Saud's Oil guzzler.

All that did was to suck the Oil into the fiat bonanza world.

Something the Sauds don't appreciate anymore as the Fiat pile is making Pax Americana fragile and it cannot zero hedge its support of Sunni Saudi hubris. It has to HEDGE with IRAN...now having showed its resilience after 40 years of confronting the USA.

C'mon Genius don't just mumble in your libertarian beard, put up or shut up.

hxc

Not all monetarists are chicagoan. They became book cookers for Keynesian discretionary policy... Hence NK's, New Classicals, "market monetarists," et cetera. Friedman's been reduced to the guy in the back room, wearing a green visor and rigging up Keynes' insane monetary system.

Check it out

The Perversion of Monetarism

MASTER OF UNIVERSE

Agreed, but only because you know more than I do when it comes to Economics, and because I always thought that cocksucker Freidman, and the Chicago School, were crooked snakes-in-the-grass all along. And frankly, Z/H does kind of beat on Keynes a bit too much sometimes, but the SOB is dead, so who cares anyhow. Historiography has a nothing to do with reality in this day and age, methinks.

falak pema

1946 Keynes dies. 1965 De Gaulle starts talking about "exorbitant privilege" and US hubris.

At the end of the 60s the London Gold club that tries to bridge French concerns about US spending profiglacy (Vietnam war, great society) and US balance of trade deterioration, collapses. Harold Wilson caves in to "gnomes of Zurich" and London loses pivotal role with a devalued £.

By 1969 the French have put the fear of God up Nixon when a french gunboat arrives reclaiming French gold deposited in NY. SO...1971 and Nixon makes the plunge.

You can say what you like about Keynes. He had nothing to do with Nixon/Johnson's spending spree which made gold revoke inevitable. It was not his philosophy which was à la mode in 1969 but the Chicago school.

MASTER OF UNIVERSE

From what I have read about Keynes he was appropriately characterized as 'brilliant'. Of course, no amount of Keynesian Stimulus could have shut down the Bear Stearns bear raid, or the Lehman Bros. Chapter 11. Ergo, the downfall of Freidman's orthodoxy was bound to occur as soon as Glass-Steagall deregulation provided the leverage via the FCC. Since the exemption on leverage for Bear Stearns it took five years to melt down to a systemic Worldwide intractable problem. Keynes was right about CB intervention, but he had no way of knowing that certain fundamentals would be altered beyond logic of failsafe.

p.s. thanks for going into detail on history. I always appreciate historical background given my background in Experimental Psychology/Personality/Biography/Historiography and Sociology.

withglee

Nixon's estimable free market advisors who gathered at the Camp David weekend were to an astonishing degree clueless as to the consequences of their recommendation to close the gold window and float the dollar.

Oh really? What would you have done ... with the street price of gold at over $70, the official price at $35, and the French choosing to be compensated in gold rather than dollars, as they were supposedly the same thing.

What would you have done?

knukles

Another reason the Chitown Loop banks were not supportive of Melamed's currency futures ideas was that the Harris primarily was at the time "the" Bulge Bracket Big Swinging US Based Dick of the cash and forward 4X markets as well as one of the largest financers of the futures businesses on the CME and CBoT. They saw Leo not as a product extension, but a threat to their dominance.

withglee

When currency exchange rates were firmly fixed and some or all of the main ones were redeemable in a defined weight of gold,

With, then as now, less than an ounce of gold per person on Earth, a third grader had arithmetic skills enough to know this was a ridiculous claim.

armageddon addahere

Everybody acts like Nixon closing the gold window was the beginning of something. It wasn't. It was the end. At that point the US had been spending money like water overseas for everything from the Marshall Plan, Volkswagens and Japanese transistor radios to the Korean and Vietnam wars. There was a net inflow of gold during the depression and WW2, but after that there was a steady outflow all through the fifties and sixties.

The whole world wanted American dollars, and a lot of it got turned in for American gold. The gold was nearly gone. At the rate it was going, the last ounce would leave Fort Knox in less than two years. They had no choice but to end the convertability of gold - sooner or later. Nixon's only choice was to take action and make a smooth transition or let everything go to hell at once.

most-interesting-frog-world

Bear

"The Great Deformation by David Stockman" ... This is the most remarkable treatise on economic history ever written. If you haven't read it you are still in the dark.You will continue to see many excerpts from this book on ZH ... and well deserved.

David Stockman should be given a Nobel Prize for Economics ... for exposing Economics as the insanity it is and fully captive to politics.

[Jul 11, 2015] Gold Daily and Silver Weekly Charts - Some Group Is Sitting On These Markets

Jul 11, 2015 | jessescrossroadscafe.blogspot.com
"Gold is looking like the dog that just did not bark -- but not uniquely so. Most safe-haven assets are looking distinctly lackluster, including the VIX index. Either 5,000 years of safe-haven buying has just become bunk, or there is a desire to portray what is evidently a financial and economic crisis as nothing to be concerned about."

Ross Norman, Sharps Pixley

"In keeping silent about evil, in burying it so deep within us that no sign of it appears on the surface, we are implanting it, and it will rise up a thousand fold in the future. When we neither punish nor reproach evildoers, we are not simply protecting their trivial old age, we are thereby ripping the foundations of justice from beneath new generations."

Aleksandr Solzhenitsyn, The Gulag Archipelago

At least in my judgement, the precious metal markets are being consistently rigged.

I believe the reason that they are being rigged is that the financiers have convinced the political class that this is a necessary action in order to prevent a panic, a run on the dollar and the bonds, and a seepage of critical funds into an unproductive investment as compared to equities for example.

We are just defending what is ours, right? And what is ours is the global dollar hegemony.

This is really just another excuse for looting, picking both the global public pockets and the Treasury's.

This sort of thing seems to happen periodically, at least once per generation, and the system generally has to get washed out badly, and then reform may come. You can see a clear trend back to the early Reagan years for this particular dalliance with the overreach and madness of the moneyed interests.

Protracted market rigging tend to distort supply profoundly. And there should be no doubt that the distortions and excesses of our current round of economic quackery have caused an historic imbalance of wealth and power. And the rigging of the gold and silver markets have badly affected the ability of supply to meet demand.

Oh well. Interesting times.

Have a pleasant evening.

[Jun 29, 2015] The Standard Definition of Money is in Error by Yves Smith

June 29, 2015 | nakedcapitalism.com

Yves here. This post is elegant in the way it challenges the standard (sloppy) definitions of money. Even if you don't agree, it will force you to think and articulate why you don't agree (hopefully in a rigorous manner).

Many people try to attribute a solidity to money (I suspect German has better words that correspond to "thing-ness" for this sort of ideation) that it lacks. The desire to have money be concrete seems to be linked in many cases to the enthusiasm for gold or gold-currencies. But gold's value isn't enduring or fixed in any way; it's value depends on the structure of social relations. For instance, in Vietnam, women typically get a necklace of gold beads in their youth. It's a dowry of sorts. When conditions became desperate during the war, some women would try trading these beads for food or medicine, or as a way to buy off a possible rapist. The beads, when they were accepted, went for much less than the metal value.

Originally published at Another Amateur Economist

The standard definition of money is in error.

The standard definition of money is given in terms of its three functions:

1: Money is a medium of exchange.
2: Money is a measure of value.
3: Money is a store of value.

Number 1 is at best misleading. Numbers 2 and 3 are simply wrong, and these things are easy to show. It is also easy to show that this is important.

First, the actual definition of money:

1: Money is a token, or instrument, of demand, which is exchanged for goods or services. Or simply: Money is demand.
2: Money is a measure of demand.
3: Money is a store of demand.

In the standard definition, Number 3 cannot possibly be true. Were Number 3 true, money would have value of itself. The value of money would be independent of what ever else an economy produced. But consider, the best monies are those instruments which have no intrinsic value whatever. How can any amount of something which has no value, be a store of value? Even where commodities have been used for money, (and this may be the origin of the error,) they have tended to be those commodities, precious metals, for instance, which, because of their properties, were of only limited economic use. The reason for this is known and simple: These commodities had to be more valuable as money than they were valuable as commodities. If they were more valuable as commodities, they would be consumed, and so their use as money would disappear. But this implies that the value of these commodities, as money, over their value as a commodity, is not intrinsic, but as with plain fiat money, purely a matter of other factors. That is, the value of the commodity as money is not based on any intrinsic value of the commodity to the economy.

So fiat money has no intrinsic value, and therefore cannot be a store of value. If the economy produced only money, that money would have no value. It does not have value as, say, a refrigerator full of food has value, or a tank filled with gasoline. But, what the third function of money actually is is as a store of demand. If you have $100 in the bank, or in your pocket, you have a store of demand, which you can keep as long as you want, and when you choose to, you can spend it. You can demand something which is offered for sale, to the amount of $100.

Then you can take your $100 of tokens of demand and you can go to the grocery store and with it buy $100 worth of food. This shows that money is also a measure of demand: You have as much demand for food, or anything else, as $100 will purchase. If you have more money, you have more demand. If you have less money, you have less demand. If you have no money, you have no demand.

Money is not a store of value. Can it reliably be a measure of value? Economically worthless things may be in much demand, and therefore command a price beyond their value. Yachts, for instance. Economically valuable things may be in little demand, or supplied at prices below their value. Water, for instance. With money, you have demand for these things, at the prices they are offered. But their prices do not reflect their economic value, only the amount of demand, the amount of money, which must be exchanged for them.

This counters the claim that the only value a thing has is that set and measured by the market: The toys of the wealthy are much in demand, but of little value. The goods needed by the poor are to them of great value, but it may be that those poor are only able to demand a meager portion of them. Markets only measure demand. They need not measure value. This is the primary inadequacy of markets.

So because money is demand, or more exactly a token or instrument of demand, it serves as a 'medium' of exchange: Because money is not demand for any particular good or service, but is demand for any offered good or service, it may be exchanged for any offered good or service. Money is a medium not in the sense of being an environment for exchange, but in the sense of being a generalized instrument. It is an abstract good, which is offered in exchange for other goods and services. The individual who exchanges his good or service for money then himself has equal demand on others for different goods or services. Money thus flows opposite to the flow of goods and services, not to the degree of the value of these goods and services, but according to the demand for these goods and services that are offered.

Goods or services are thus exchanged for an equal demand on other goods or services. Money, then, is an instrument for comparing the demand for dissimilar objects. However, we have shown it is not reliable for comparing the value of dissimilar objects.

By mistaking demand for value, the standard definition of money thus implicitly fails to distinguish between the value of an object, and the demand for that object. In an informal sense, this results in the failure to distinguish between the needs of an economy, and its wants.To provide another example, the economy 'needs' streetlights in Highland Park, Mi. It 'wants' yachts in Newport, RI.

If we regard the economy as like a tree, money cannot distinguish between the fruits of a tree, and its roots.

There is a larger issue. The standard definition of money goes back, essentially unchanged, to 1875. See eg. Wikipedia. It is, implicitly, a key part of the foundations of the entire field of economics. That it is in error calls into question the soundness of the entire economics project.

[Jun 19, 2015] Banks are Not Intermediaries of Loanable Funds – and Why This Matters by Yves Smith

June 19, 2015 | naked capitalism
Yves here. Over the years, we've regularly criticized economists like Bernanke and Krugman, who rely on the so-called loanable funds model, which sees banks as conduits of funds from savers to borrowers. Despite the fact that many central banks, such as the Bank of England, have stressed that that's not how banks actually work (banks create loans, which then produce the related deposit), central banks still cling to their hoary old framework. For instance, when I saw Janet Yellen speak at an Institute of New Economic Thinking conference in May, she cringe-makingly mentioned how banks channel scarce savings to investments.

Even worse, the macroeconomic models used by central banks incorporate the loanable funds point of view. This article describes what happens when you use a more realistic model of the financial system. Even though the paper is a bit stuffy, the results are clear: economies aren't self-correcting as the traditional view would have you believe but have boom/bust cycles (the term of art is "procyclical") and banks show the effects of policy changes much more rapidly.

Other economists who have been working to develop models that reflect the workings of the financial sector more accurately, like Steve Keen, have come to similar conclusions: that the current mainstream models, which serve as the basis for policy, present a fairy-tale story of economies that right themselves on their own, when in fact loans play a major, direct role in creating instability. It's not an exaggeration to depict the continued reliance on known-to-be-fatally-flawed tools as malpractice.

By Zoltan Jakab, Senior Economist at the Research Department, IMF, and Michael Kumhof, Senior Research Advisor at the Research Hub, Bank of England. Originally published at VoxEU

Problems in the banking sector played a seriously damaging role in the Great Recession. In fact, they continue to. This column argues that macroeconomic models were unable to explain the interaction between banks and the macro economy. The problem lies with thinking that banks create loans out of existing resources. Instead, they create new money in the form of loans. Macroeconomists need to reflect this in their models.

Problems in the banking sector played a critical role in triggering and prolonging the Great Recession. Unfortunately, macroeconomic models were initially not ready to provide much support in thinking about the interaction of banks with the macro economy. This has now changed.

However, there remain many unresolved issues (Adrian et al. 2013) including:

• The reasons for the extremely large changes to (and co-movements of) bank assets and bank debt;• • The extent to which the banking sector triggers or amplifies financial and business cycles; and
• The extent to which monetary and macro-prudential policies should lean against the wind in financial markets.

New Research

In our new work, we argue that many of these unresolved issues can be traced back to the fact that virtually all of the newly developed models are based on the highly misleading 'intermediation of loanable funds' theory of banking (Jakab and Kumhof 2015). We argue instead that the correct framework is 'money creation' theory.

In the intermediation of loanable funds model, bank loans represent the intermediation of real savings, or loanable funds, between non-bank savers and non-bank borrowers;

Lending starts with banks collecting deposits of real resources from savers and ends with the lending of those resources to borrowers. The problem with this view is that, in the real world, there are no pre-existing loanable funds, and intermediation of loanable funds-type institutions – which really amount to barter intermediaries in this approach – do not exist.

The key function of banks is the provision of financing, meaning the creation of new monetary purchasing power through loans, for a single agent that is both borrower and depositor.

Specifically, whenever a bank makes a new loan to a non-bank ('customer X'), it creates a new loan entry in the name of customer X on the asset side of its balance sheet, and it simultaneously creates a new and equal-sized deposit entry, also in the name of customer X, on the liability side of its balance sheet.

The bank therefore creates its own funding, deposits, through lending. It does so through a pure bookkeeping transaction that involves no real resources, and that acquires its economic significance through the fact that bank deposits are any modern economy's generally accepted medium of exchange.
The real challenge

This money creation function of banks has been repeatedly described in publications of the world's leading central banks (see McLeay et al. 2014a for an excellent summary). Our paper provides a comprehensive list of supporting citations and detailed explanations based on real-world balance sheet mechanics as to why intermediation of loanable funds-type institutions cannot possibly exist in the real world. What has been much more challenging, however, is the incorporation of these insights into macroeconomic models.

Our paper therefore builds examples of dynamic stochastic general equilibrium models with money creation banks, and then contrasts their predictions with those of otherwise identical money creation models. Figure 1 shows the simplest possible case of a money creation model, where banks interact with a single representative household. More elaborate money creation model setups with multiple agents are possible, and one of them is studied in the paper.

Figure 1.

kumhof fig 1 17 jun

The main reason for using money creation models is therefore that they correctly represent the function of banks. But in addition, the empirical predictions of the money creation model are qualitatively much more in line with the data than those of the intermediation of loanable funds model. The data, as documented in our paper, show large jumps in bank lending, pro- or acyclical bank leverage, and quantity rationing of credit during downturns. The model simulations in our paper show that, compared to intermediation of loanable funds models, and following identical shocks, money creation models predict changes in bank lending that are far larger, happen much faster, and have much larger effects on the real economy. Compared to intermediation of loanable funds models, money creation models also predict pro- or acyclical rather than countercyclical bank leverage, and an important role for quantity rationing of credit, rather than an almost exclusive reliance on price rationing, in response to contractionary shocks.

The fundamental reason for these differences is that savings in the intermediation of loanable funds model of banking need to be accumulated through a process of either producing additional resources or foregoing consumption of existing resources, a physical process that by its very nature is gradual and slow. On the other hand, money creation banks that create purchasing power can technically do so instantaneously, because the process does not involve physical resources, but rather the creation of money through the simultaneous expansion of both sides of banks' balance sheets. While money is essential to facilitating purchases and sales of real resources outside the banking system, it is not itself a physical resource, and can be created at near zero cost.

The fact that banks technically face no limits to instantaneously increasing the stocks of loans and deposits does not, of course, mean that they do not face other limits to doing so. But the most important limit, especially during the boom periods of financial cycles when all banks simultaneously decide to lend more, is their own assessment of the implications of new lending for their profitability and solvency. By contrast, and contrary to the deposit multiplier view of banking, the availability of central bank reserves does not constitute a limit to lending and deposit creation. This, again, has been repeatedly stated in publications of the world's leading central banks.

Another potential limit is that the agents that receive payment using the newly created money may wish to use it to repay an outstanding bank loan, thereby quickly extinguishing the money and the loan. This point goes back to Tobin (1963). The model-based analysis in our paper shows that there are several fallacies in Tobin's argument. Most importantly, higher money balances created for one set of agents tend to stimulate greater aggregate economic activity, which in turn increases the money demand of all households.

Figure 2 shows impulse responses for a shock whereby, in a single quarter, the standard deviation of borrower riskiness increases by 25%. This is the same shock that is prominent in the work of Christiano et al. (2014). Banks' profitability immediately following this shock is significantly worse at their existing balance sheet and pricing structure. They therefore respond through a combination of higher lending spreads and lower lending volumes. However, intermediation of loanable funds banks and money creation banks choose very different combinations.

Figure 2. Credit crash due to higher borrower riskiness

kumhof fig2 17 jun

Intermediation of loanable funds banks cannot quickly change their lending volume. Because deposits are savings, and the stock of savings is a predetermined variable, deposits can only decline gradually over time, mainly by depositors increasing their consumption or reducing their labour supply. Banks therefore keep lending to borrowers that have become much riskier, and to compensate for this they increase their lending spread, by over 400 basis points on impact.

Money creation banks on the other hand can instantaneously and massively change their lending volume, because in this model the stocks of deposits and loans are jump variables. In Figure 2 we observe a large and discrete drop in the size of banks' balance sheet, of around 8% on impact in a single quarter (with almost no initial change in the intermediation of loanable funds model), as deposits and loans shrink simultaneously. Because, everything remaining the same, this cutback in lending reduces borrowers' loan-to-value ratios and therefore the riskiness of the remaining loans, banks only increase their lending spread by around 200 basis points on impact. A large part of their response, consistent with the data for many economies, is therefore in the form of quantity rationing rather than changes in spreads. This is also evident in the behaviour of bank leverage. In the intermediation of loanable funds model leverage increases on impact because immediate net worth losses dominate the gradual decrease in loans. In the money creation model leverage remains constant (and for smaller shocks it drops significantly), because the rapid decrease in lending matches (and for smaller shocks more than matches) the change in net worth. In other words, in the money creation model bank leverage is acyclical (or procyclical), while in the intermediation of loanable funds model it is countercyclical.

As for the effects on the real economy, the contraction in GDP in the money creation model is more than twice as large as in the intermediation of loanable funds model, as investment drops more strongly than in the intermediation of loanable funds model, and consumption decreases, while it increases in the intermediation of loanable funds model.

Banks are Not Intermediaries of Real Loanable Funds

To summarise, the key insight is that banks are not intermediaries of real loanable funds. Instead they provide financing through the creation of new monetary purchasing power for their borrowers. This involves the expansion or contraction of gross bookkeeping positions on bank balance sheets, rather than the channelling of real resources through banks. Replacing intermediation of loanable funds models with money creation models is therefore necessary simply in order to correctly represent the macroeconomic function of banks. But it also addresses several of the empirical problems of existing banking models.

This opens up an urgent and rich research agenda, including a reinvestigation of the contribution of financial shocks to business cycles, and of the quantitative effects of macroprudential policies.

Disclaimer: The views expressed here are those of the authors and do not necessarily represent those of the institutions with which they are affiliated.


craazyboy, June 19, 2015 at 11:35 am

Actually, the concepts of the money multiplier [hence the related concept of "bank money"] and loanable funds both existed simultaneously in my econ 101 book in college. But they were in different chapters.

The money multiplier, a consequence of fractional banking, does have a mathematical limit and it depends on the reserve ratio. Of course since banks are in the middle, they have control over whether they lend to the limit or not, if loan demand is there. If no loan demand, they would be "pushing on string", which was in yet another chapter in my econ 101 book.

A common layman misinterpretation of the money multiplier is that banks have their own printing press. That is not true – the banking system a whole creates bank money. When a loan is made, the bank now has an "asset" on it's balance sheet. That where "capital ratios" come into play limiting an individual bank.

craazyboy, June 19, 2015 at 11:07 am

Capital ratios, depending on how many SIVs you have. But if you get limited there, those numbers can be fudged. Or if you don't like faking complicated financial statements, you can always say, "faakit, I don't wanna be a bank. I'll be a CDO mill instead. Then maybe expand into insurance with CDS. That sounds better."

But economists are hopeless. They spend 50 years arguing over whether the sky is blue or green, then one comes along and says it's blue-green.


susan the other, June 19, 2015 at 11:32 am

Yes. Big ones. So big that it became necessary to start writing up more derivative contracts than loan contracts. This post explains derivatives better than anything I have read and it doesn't mention them once! But really, why else would Greenspin love them so much. Because it was the perfect way for banks to have all the cake and eat all the cake.

As long as banks' balance sheets were OK, they were OK, except that they could crash the entire world economy and then, oops, they weren't OK any more.

So enter derivatives to ensure their own balance sheets. Problem solved.

sardonic
June 19, 2015 at 11:05 am

This is not academese, it's the reality. Read the BoE explanation of the same in Money creation in the modern economy.

Banks create money when they issue loans to others: they obviously can't issue a loan to themselves should they find themselves in a liquidity/solvency crunch. Hence the need for bailouts by somebody else.


Nathan Tankus, June 19, 2015 at 2:26 pm

This is the problem with using imprecise language like money.

Banks create deposits which are money to non-bank businesses, individuals, state and local governments and sometimes foreign governments. Deposits are however, not money to other banks. Settlement balances (money in essentially bank's checking accounts at the central bank) are money to them (in the sense that they can use them to settle their liabilities). A bank needs these to clear payments with other banks and the government.

Normally the central bank makes sure there are enough settlement balances in the system to clear payments between banks and those balances are distributed through the banking system when banks make daily unsecured loans to each other. In the crisis however, since all these loans were unsecured, banks stopped lending to each other. The government then had to guarantee interbank loans in the trillions to get the payments system functioning again.

Bailouts serve to make people believe the financial system is stabilized and to increase their official capital levels (capital levels matter because regulators are supposed to take over and resolve banks that are under-capitalized or even have negative equity). They are however, not essential to keep these banks going.

Letting banks lie about the value of their assets (which happened on a widespread level after the financial crisis) is just as effective as keeping these banks running as official bailouts.

The dirty little secret is that as long as the central bank makes sure that banks can borrow on the inter-bank loan market (or directly lend to them) and regulators all agree to lie (or not check) about the net worth and capital levels of a bank, they can stay in business. This is the nature of accounting control frauds in the modern age.

washunate, June 19, 2015 at 3:25 pm

So that leaves my original question. What is the policy value of the semantics?

In your description, banks are still constrained in their ability to lend. In order to loan more, to create new money, government has to make sure the bank IOUs are interchangeable with the national currency.

Nathan Tankus, June 19, 2015 at 3:45 pm

a) this is not true. in payment systems where bank liabilities don't trade at par (like antebellum united states) what adjusts is the value of the liabilities, not the banks ability to issue liabilities.

b) the definition of a modern currency is making sure that insured deposits in the same country equal each other in value. The most important Central Bank mandate is to preserve the integrity of the payments system. not putting enough settlement balances into the banking system means making interest rates explode and the payments system freeze. If you think that banks are at all constrained in lending by the threat of the central bank deliberately blowing up the payments system country wide, I have some penny stocks i would like you to invest in. What's interesting about Europe right now is that they don't have a "federal" (as in europe wide) insured deposit system and thus there is no such thing as insured deposits in the normal sense. as a result the ECB has blown up the payments system in cyprus and seems to be contemplating doing the same in Greece and wrote down deposits (in many ways like the antebellum banking system). Note that even in this case lending hasn't been constrained, the resulting liabilities have just been written down and may be written down in the future.

C) saying that banks are "constrained in lending" when this "constraint" is something that doesn't exist in the real world ie the United States and most central banks in the world refusing to provide the necessary amount of settlement balances to clear payments between banks at par is much more of a semantic game with no value for understanding policy than the reverse.

washunate, June 19, 2015 at 4:02 pm

I hear what you are saying. What you are saying is that there is no alternative.

The public must bail out the banksters.

Ben Johannson, June 19, 2015 at 2:37 pm

They can't create money for the payments system. U.S. banks don't make dollars. British banks don't make pounds sterling. They make bank IOUs for the deposit system.

Code Name D, June 19, 2015 at 3:32 pm

I am not sure this is completely true. The point of secularization is to sell these assets into the shadow markets. So not the markets hold the assets just created by the banks while the bank takes their money in exchange.

To create more money, all they have to do is find more loans to underwrite, then secularize the results.

Ben Johannson, June 19, 2015 at 3:49 pm

Banks can create money denominated in the government's currency but they can't create that currency. If you get a bank loan for $10,000 you're being given a bank IOU with a value of $10,000 - which means the bank isn't actually loaning you anything at all. They're agreeing to clear a payment through the reserve system in exchange for a series of small payments from you in the future.

Actual dollars can only exist in a reserve account or as cash.

OpenThePodBayDoorsHAL, June 19, 2015 at 4:22 pm

So far no one is mentioning the elephant in the room: why are money and credit necessarily interconnected?

We could certainly have money, produced in a quantity that matched underlying economic activity or population growth or something. On top of that we could have savings, investment, fractional lending etc.

Instead we have a system where every banking crisis is also a monetary crisis.

Milton Friedman suggested a desktop computer that created 2% more money each year.
Then there are those who suggest using some rare, shiny substance that is materially difficult to obtain:

http://www.alt-m.org/2015/06/04/ten-things-every-economist-should-know-about-the-gold-standard-2/

Instead when we get a banking crisis (year 7 and counting) the only possible response is to flood the system with scrip, with predictable results (runaway inflation, this time in financial assets, last time in housing, the time before in commodities). Everybody moaning about the plunge in oil prices, but nobody seems to ask how/why they got to $140/bbl in the first place. Excess capacity everywhere you look, from Chinese steel to US college grads.

So let's have a real debate, not just argue how many angels are on the head of our current money/credit pin.

washunate, June 19, 2015 at 3:33 pm

Yeah, we very much agree here. Banks can create bank IOUs. Just like I can create wash IOUs. I, wash, do solemnly and seriously promise to give you a trillion dollars next week.

Now, gimme a trillion dollars today!

If the government backs my $1 trillion promise, then the government created the money, not me. If the government doesn't back my promise, then it ain't worth jack squat in payments systems. I couldn't even buy a coffee at Starbucks with it, nevermind a car or a house or something.

craazyman, June 19, 2015 at 4:32 pm

How does a dude driving a car with a gas gauge run out of gas?

hahahahah

If you fkk things up so bad you can't pay for your money making machine to make money then you can't make money. But it's not cause you can't make money, it's because you can't pay for your money making machine to crank it out1

How do all these boneheads get so rich if they can't make money? They could never get that rich if they just loaned money that was already there. No way.

They don't get rich linearly. They get rich exponentially. that's inconsistent with Not making money whenever they want. Loanable funds is linear. Making is exponential.

Where does the money come from if they dont make money? The first bank had to have money to start. where did that come from? It might have come from the govermint. But the govermint had to borrow it from people. They probably got it from a bank someplace that cooked it up. There was probably a bank in the Garden of Eden. That's probably what the snake was. A Banker. hahahahahahah. The apple was a loan. Then reality set it when Adam and Eve realized they had to hit the mall to buy some clothes so they could look for jawbs to pay it off.

craazyboy

June 19, 2015 at 4:45 pm


You read that in David Graeber's book, didn't you?

susan the other, June 19, 2015 at 11:37 am

They can create money as long as there is someone to loan it to. Bec. they have to mind their own assets and liabilities to be legit.

But the trick is that they don't have to pay attention to reality as long as their books balance. It is such a clever fiction.

Theoretically it could work to smooth the bumps in an economy, except that it causes such precipitous crashes nobody can recover. One small detail.

washunate, June 19, 2015 at 12:32 pm

How can an entity that can create money ever have unbalanced books?

todde, June 19, 2015 at 12:43 pm

When the economy starts to shrink, earning potential goes down as do asset prices.

This prevents banks from making new loans. Banks loans are a function of past and future earnings.

At the same time the ability of the debtor to repay loans on the books is also curtailed.

This leads to a bailout.

cripes, June 19, 2015 at 3:37 pm

@washunate:

Now you're being obtuse. Deliberately?

It's clear they can create asset-money by loaning asset-money to borrowers.

We're not talking about paper bills here, which are a very small part of circulating "money."

washunate, June 19, 2015 at 3:44 pm

No, this is very important. A currency issuer can issue unlimited amounts of currency.

An entity that is not a currency issuer cannot. They are constrained by the existing resources.

human, June 19, 2015 at 11:41 am

Of course banks don't _need_ bailouts. They get them because they are able to coerce the populace through the great circle jerk of the Loanable Funds model!

washunate, June 19, 2015 at 12:30 pm

What do you mean banks don't need bailouts?

human, June 19, 2015 at 12:53 pm

Bailouts are used to bolster the publics' perception of the Feds' regulatory authority and responsibility and spread some more wealth around. Look at what happened to AIG!

washunate, June 19, 2015 at 1:01 pm

Exactly, look at what happened. Goldman Sachs would have ceased to exist without government support. The smartest bank on the planet was incapable of creating money.

human, June 19, 2015 at 1:39 pm

"ceased to exist" I find that very hard to believe. They might have had to cut bonuses…maybe.

washunate, June 19, 2015 at 3:40 pm

Well sure, we can't prove something that didn't happen. But we can point to how desperate actors behaved at the time. For example:

In light of the unusual and exigent circumstances affecting the financial markets, and all other facts and circumstances, the Board has determined that emergency conditions exist that justify expeditious action on this proposal

Unusual, exigent, emergency, and expeditious. In just one sentence.

http://www.federalreserve.gov/newsevents/press/orders/orders20080922a1.pdf

human, June 19, 2015 at 3:53 pm

Desperate?! They were handed an opportunity to gorge at the Fed discount window by becoming a bank holding company!!! They didn't hesitate and the rest is history.

Your comprehension seems to be so much neoliberal twaddle…meant for the proles. Of course they had their avarice covered by so much high-sounding legalese.

Benedict@Large, June 19, 2015 at 3:23 pm

If banks could create new money, they wouldn't need government bailouts.

Also, If banks could create new money, they wouldn't need to borrow depositors' money.

And, If banks could create new money, you wouldn't need depositors' insurance.

All of these speak to the "banks create money" idea as nonsense. Banks create credit.

However, the "loanable funds" idea is still nonsense. Loans are both made from and deposited to loanable funds, for a net of zero. This is critical, because it completely nullifies the idea that government borrowing affects interest rates by creating a shortage of funds.

Government spending does not slow other financial activity in the economy, which means the entire conservative paradigm in macroeconomics is garbage.

washunate, June 19, 2015 at 3:59 pm

Well said, it's all nonsense.

Personally I would tweak "banks create credit" to more specifically say that banks convert borrower credit into government credit. It's a transformation, an exchange, not an act of creation.

It's the borrower, not the bank, that supplies the credit. Indeed, a bank that systematically makes loans exceeding their borrower's ability to repay quite predictably goes out of business.

Vatch, June 19, 2015 at 4:08 pm

As Sardonic and Susan the Other have both pointed out, banks create money only when they issue loans to others. They aren't able to create money in any other ways. If there aren't borrowers, then the banks can't create money.

And when someone fully repays her or his bank loan, the money that was created by that bank loan is destroyed.

But of course the bankers have a multitude of ways to game the system.

fledermaus, June 19, 2015 at 10:57 am

It's easy to make money when you can lend the same $100 to ten different people.

sardonic, June 19, 2015 at 11:14 am

Money is credit, so your statement does not make sense. What is happening in the scenario you imagine is you are creating ten different loans. These dollars are no more "same" than are numbers in different banks demand deposit accounts.

todde, June 19, 2015 at 11:02 am

Since we run massive trade deficits there are.always dollars.offshore that can be lent to banks to meet any reserve requirements.

So banks ability to make.loans and create money would be a function of society's ability to repay.

Another point, banks don't create money out of thin air, they create money based on prior earnings (secured loans) or future earnings (unsecured loans).

Ben Johannson, June 19, 2015 at 2:41 pm

Bank loans aren't derived from cash flow, they are entries on the balance sheet. They come from nowhere and go back to nowhere when a loan is paid back.

Also, all dollar deposits exist within the computers of the Federal Reserve so there's nothing "offshore" to bring back.

todde, June 19, 2015 at 2:51 pm

Not all dollar reserves are sitting in the federal reserve , although many are.

And cash flow of the borrower matters.

Ben Johannson, June 19, 2015 at 3:08 pm

All dollar deposits exist on computers at the Federal Reserve. Anyone at the Fed, Treasury and CBO can tell you this.

Cash flow of the borrower is a matter of underwriting standards, not capacity to extend a loan.

Jesse, June 19, 2015 at 11:14 am

Are all 'banks' the same?

In a regime where the banking authority imposes a strict 50% reserves requirements and eliminates the gimmickry of overnight sweeps to gimmick the base of assets and liabilities, and stresses certain types of higher quality reserves and a conservative valuation, are the 'banks' the same as a regime where reserve requirements are minimal and easily financialized?

Is an economy where loans are intimately tied to organic growth through 'real' economic activity and a high velocity of money (sorry Austrians but it does mean something) different from one in which the banks are largely preoccupied with speculating with their own trading books and money supplied by the central banking authority monetizing debt?

A model that fits a particular circumstance which is itself is rather distorted from the historical norm is just that. An example of a particular circumstance and not a general model for a range of conditions.

susan the other, June 19, 2015 at 11:53 am

This post was killer. It left us all with the question, Well just how do we change our financial behavior to fit the real model, the money creation model. Because we all went blithely on our way for decades thinking things were balancing out when in fact they weren't.

It sounds a little Minsky, in that the good times always crash but nobody knows what to do about it. So at least Minsky had an inkling of this. And there were plenty of crashes when banks really did intermediate loans, but they were recoverable.

When did loan intermediation end? 1913 and with the creation of the Federal Reserve? If so it is amazing it was mythologized for so long. One way to begin to get real would be to analyze the value of money, and its creation, by what it accomplishes. So, that's after the fact and hard to do in a "free market" but the FM is also another myth. MMT looks at this very clearly. We don't need loans to run the sovereign business of the country. That takes care of a large chunk of the mess right off the top.

susan the other , June 19, 2015 at 2:12 pm

yes. it's scary. Mistakes are easier to make than progress. But we have much better analytics now… maybe we can estimate what will happen and actually maintain a steady course. I'd like to think that.

Synoia, June 19, 2015 at 12:08 pm

Step 1. When did loan intermediation end? 1913 and with the creation of the Federal Reserve?

Step 2. Getting off the gold standard in 1972.

Min, June 19, 2015 at 12:26 pm

Back in the free banking era of the 19th century, there was a bank in Rhode Island that issued $600,000 in bank notes backed by 7 bits ($0.875 in coins) in the vault. ;)

Source: A talk on CSPAN book TV a few years ago. Sorry I can't be more definite.

craazyboy, June 19, 2015 at 1:06 pm

That was back when we/Europe were still trying to decide if we should do fractional gold banking, or if banking based on the banker's reputation was adequate. 'Course bankers found that cheating on fractional gold banking was very profitable as well.

Adam1, June 19, 2015 at 1:12 pm

The basis of loans create deposits has been around since shortly after the creation of double-entry bookkeeping. The FED's existence only stabilizes and standardizes the interbank clearing process and has little to do with loans create deposits. The gold standard only fixed foreign exchange rates and floated domestic rates, it had little impact on loans create deposits.

Larry Headlund, June 19, 2015 at 12:53 pm

When did loan intermediation end?

According to Lombard Street (1873) by Walter Bagehot lending as a function of 'banks' preceded their accepting of deposits by some years.

Min, June 19, 2015 at 12:21 pm

Can't we all agree that banks create money? Fractional reserve banking makes no sense unless banks create money. I learned that in high school, fer crissakes!

washunate, June 19, 2015 at 12:58 pm

No, we can't.

:)

But seriously, it's important to understand why there are differences of opinion. The monetarists (of all stripes, this is not a left/right thing) want people to think that money (as in currency) is created by banks because that obfuscates the real actor – the government.

When the government accepts the bank IOU as exchangeable 1:1 with the national currency, then it is the government that has created more currency units, not the bank. But if people can be convinced to ignore that little step, it looks like banks create the currency units themselves.

And once you accept those bank IOUs as legitimate currency units in the boom times, well, you've committed to a policy of bailing out criminal and/or insolvent management teams during the bust times.

Benedict@Large, June 19, 2015 at 3:30 pm

Banks don't create money. You were taught wrong. The model used where banks create money does not match the accounting a bank uses. There is no money multiplier.

[Note that several first world countries have reserve requirements of zero percent. They do not suffer hyperinflation, as the money multiplier would suggest. Even Ben Bernanke said that the reserve percentage only affected the cost of money, and that he would have preferred the US also move to a zero percent reserve.]

craazyboy, June 19, 2015 at 4:21 pm

Banks create credit, but common usage sometimes interchanges money and credit when the distinction isn't relevant to the narrow context of the discussion.

There is a money multiplier. No one made it up – if you have fractional banking it is there. Math says it can happen. You could call it a credit multiplier if you prefer, but I try and limit how many new words I make up.

The reserve ratio limits the money multiplier to a non-infinite number. The reason we have bank reserves is so in theory banks have some cash on hand to satisfy deposit withdrawals.

Capital ratios are used by regulators to monitor bank solvency. Some counties have zero reserve requirements. I guess the CBs there will FedEx your money to you. Who knows. I'll take the FDIC insurance.

Canada has a 0 reserve requirement. Canada has a housing bubble. So does Oz. The EU has even more lax capital ratio requirements than the US. The EU is now a basket case. The US has asset bubbles.

Bernanke is an a-hole.

nothing but the truth, June 19, 2015 at 1:30 pm

when Y is talking about investment / saving, she is talking about the real side of the picture.

when you are talking about the loan-> deposit causality, this is from the technicality of the financial system.

both are correct because they are talking about apples and oranges.

the money multiplier story is something that economists have spread and they are _so_ surprised to find out that it is not the (complete) truth. partly this story comes from history because that is how banks started. That is because gold is a real resource – you cannot just create it fictionally and lend it. Now that money is nothing, there cannot be a shortage of nothing, unless it is to keep the "people in their place". When the likes of Goldman have a shortage of money, it is produced out of nothing.

The view of money multiplier is correct, except for the causality part. loans create deposits, but those deposits belong to someone.

From the operational side of things, there is not much difference. Whether the bank creates loans and then deposits, or deposits first and then loans, the fact remains that the bank is on the hook for the loan (to its capital reserves) if it defaults, so the bank has to be careful whom to lend to. Reckless lending can even lead to jail time for the lender (or it used to).

so long store short, there is not much to see in this technical view of things. Yes under the hood the car is very complicated, has 80+ microprocessors and so on. The function of the car is to be driven. To obsess about spark plugs is to forget the function of the car – transport.

This is the real question – what is the function of money in the real economy, who is benefiting from the legalized frauds, and how to stop this and bring finance to serve the real economy, not vice versa. This is political economy, not really finance. Yes to fix something you have to understand it. But it should be understood that we diagnose in order to prescribe.

DolleyMadison, June 19, 2015 at 2:01 pm

Wow – A few days ago Maxine Waters wrote an op-ed about the 2-tier justice system when it comes to bankers – surprisingly printed by American Banker. So I try to click on it and the link is DEAD. So I search for the article and found it cross posted on 3 other sites – and on each one the link was broken. WOW. And we wonder how the "2-tier justice system" became that way…
See dead links below:

Big Banks and America's Broken, Two- Tiered …
http://www.americanbanker.com/bankthink/big-banks-and-americas...

Jun 16, 2015 · In February, federal prosecutors began a 90-day examination to determine whether to bring cases against individuals for their role in the 2008 financial …
Big Banks and America's Broken, Two- Tiered …
grabpage.info/t/www.americanbanker.c…/bankthink/big…Cached

America, American, Bank, Banker, Banks, Big, Bond, Broken, Buyer, Justice, Mortgage, National, News, PaymentsSource, System, The, Think, Tiered, Two, and
Big Banks and America's Broken, Two- Tiered …
housingindustryforum.com/industry-newswire/american…Cached

Jun 16, 2015 · … Two-Tiered Justice System By American Banker | June 17, 2015. SHARE Read Article. Comments.

Lambert Strether, June 19, 2015 at 3:07 pm

Adding epicycles to dynamic stochastic general equilibrium models, because markets (I would argue) do not equilibriate (though they may be equilibriated, as with LIBOR).

Trying to make a "like a fish needs an epicycle" joke here, but gotta run….

pcle, June 19, 2015 at 3:23 pm

"Figure 2 shows impulse responses for a shock whereby, in a single quarter, the standard deviation of borrower riskiness increases by 25%."

So it looks like in this model "shocks" just come from outer space. There is no sense in which the system itself generates crisis as part of its very working ? And where's the fraud parameter ?

Jesper

June 19, 2015 at 4:00 pm


Some central bankers believe that banks create money.
Some central bankers believe that financial markets can self-regulate.

Given the above facts about central bankers, can we conclude if central bankers always know what they are talking about (even when it comes to monetary policy)?

Reply ↓


horostam

June 19, 2015 at 4:05 pm


ok, so I understand that loans create deposits, but…im confused about the reverse.

I have this crazy exercise i try to do.

I try to visualize the thought experiment of all loans and govt deficits being paid back so that there are 0 us dollars in existence. (kind of like an economic version of reimagining the big bang in reverse)

Leaving aside for the moment the fact that there is not enough money in existence to make all interest payments… (is this even true?)

how does the money get destroyed when a loan is paid back? You will say "the balance sheets are simply adjusted, a deposit and a loan simply disappear."

i can visualize this, but i dont understand it.

So what is the difference, for the bank, between a paid back loan and a default on the loan?

and what happens to the interest payments (when they are made)? they move from deposits to reserves (or equity or whatever)… how are they seperated from the deposits that simply "disappear?"

I would really like to understand this…

Reply ↓

Nathan Tankus, June 19, 2015 at 4:25 pm

"So what is the difference, for the bank, between a paid back loan and a default on the loan?"

when a person makes a principal payment on a loan their account is debited and the value of their debt (an asset to the bank) is decreased. when a person defaults on a loan the value of their debt ( again an asset to the bank) becomes zero (well actually more like pennies on the dollar since it will likely get sold to a debt collector). In other words, one shrinks the bank's balance sheet while keeping it's net worth the same while the other decreases the bank's net worth

"and what happens to the interest payments (when they are made)? they move from deposits to reserves (or equity or whatever)… how are they seperated from the deposits that simply "disappear?""

interest is paid in the same process ie debiting the borrower's account. the difference is that interest payments increase the bank's net worth since they have less liabilities ( ie less deposits) without decreasing the value of their asset (the borrower's debt).

In short, banks lend to increase their net worth.

horostam, June 19, 2015 at 4:49 pm

In other words, one shrinks the bank's balance sheet while keeping it's net worth the same while the other decreases the bank's net worth

do you mean "the banking system's net worth?"

if (in both cases) the loan asset value goes down, the only way net worth stays the same is if deposits decrease proportionately.

What if your deposit account is at another bank? What is the difference, to an individual bank, if its a default or principal payment?

Their liability side doesnt change…

Clearly i am missing something…

craazyboy, June 19, 2015 at 4:27 pm

"So what is the difference, for the bank, between a paid back loan and a default on the loan?"

In the case of default, the bank puts your house on it's balance sheet and it is then house money.

Interest is tricky. It comes from future years 31 thru 33.

Nathan Tankus, June 19, 2015 at 4:31 pm

yes i abstracted from collateral to make the basic point.

if the loan is collateralized than the fall in the bank's net worth from a default is equal to the value of the loan minus the value of the collateral.

This is part of why so many people were so cavalier about lending in the housing market because people assumed that rising capital gains would keep these loans profitable even if the rate of default increased.

Of course when housing prices fell and people started to take capital losses…. and here we are.

Angry Bear " The U.S. Inept Diplomacy, Indispensable Currency

The influence of the U.S. in financial flows extends far outside national borders. A study by Robert N.McCauley, Patrick McGuire and Vladyslav Sushko of the Bank for International Settlements estimated that the amount of dollar-denominated credit received by non-financial borrowers outside the U.S. totaled $9 trillion by mid-2014. Over two-thirds of the credit originated outside the U.S., with about $3.7 trillion coming from banks and $2.7 from bond investors. The report's authors found that dollar credit extended to non-U.S. borrowers grew much more rapidly than did credit within the U.S. during the post-global financial crisis period.

Almost half of this amount went to borrowers in emerging markets, particularly China ($1.1 trillion), Brazil ($300 billion), and India ($125 billion). In the case of Brazil, most of the funds were raised through the issuance of bonds, while bank lending accounted for the largest proportion of credit received by borrowers in China. Much of this credit was routed through the subsidiaries of firms outside their home countries, and balance of payments data would not capture these flows.

The study's authors attributed the rise in borrowing in emerging markets to their higher interest rates. Consequently, any rise in U.S. interest rates will have global repercussions. The growth in dollar-denominated credit outside the U.S. should slow. But there may be other, less constructive consequences. Borrowers will face higher funding costs, and loans or bonds that looked safe at one interest rate may be less so at another. This situation is worsened by an appreciating dollar if the earnings of the borrowers are not also denominated in dollars. The rise in the value of the dollar has already prompted reassessments of financial fragility outside the U.S.

All this puts U.S. monetary policymakers in a delicate position. Ms. Yellen has made it clear that the Fed is in no hurry to raise interest rates. The Federal Reserve wants to see what happens to prices and wages as well as unemployment before it moves. The appreciation of the dollar pushes that date further into the future by keeping inflation rates depressed while cutting into the profitability of U.S. firms. While the impact of higher rates on credit markets outside the U.S. most likely has a relatively low place on the Fed's list of concerns, Fed policymakers certainly are aware of the potential for collateral damage.

All this demonstrates the discrepancy between the diplomatic and financial power of the U.S. On the one hand, the U.S. must deal with countries that are eager to claim their places in global governance. The dominance of the U.S. and other G7 nations in international institutions is a relic of a world that came to an end with the global financial crisis. On the other hand, the dollar is still the predominant international currency, and will hold that place for many years to come. The use of the renminbi is slowly growing but it will be a long time before it can serve as an alternative to the dollar. Consequently, the actions of the Federal Reserve may have more international repercussions than those of U.S. policymakers unable to cope with the shifting landscape of financial diplomacy.

cross posted with Capital Ebbs and Flows

IMF profile of Hélène Rey

From a much longer IMF profile of Hélène Rey, professor of economics at the London Business School:

... Among her most influential work is the research she did with Gourinchas when she was at Princeton on the role of the United States in a globalized financial system. Blanchard says it "changed the discussion on the current account deficit in the United States."
Before the recent global financial crisis, when economists and politicians were concerned about the ballooning U.S. current account deficit, Gourinchas and Rey showed that the U.S. position was not as bad as it looked because of the country's role as the center of the international financial system.
"Although the U.S. was running a big trade deficit, economists were not taking into account the large amounts the U.S. was earning on the financial side from capital gains and changes in the value of the dollar," Gourinchas told F&D.
"For example, almost all U.S. foreign liabilities are in dollars, whereas approximately 70 percent of U.S. foreign assets are in other currencies. So a 10 percent depreciation of the dollar increases the value of foreign assets and represents a transfer of about 5.9 percent of U.S. GDP from the rest of the world to the United States. For comparison, the trade deficit on goods and services in 2004 was 5.3 percent of GDP. So these capital gains can be very large."
As Gourinchas and Rey (2005) pointed out, a depreciation of the U.S. dollar has two beneficial effects on the external position of the United States. It helps boost net exports and increases the dollar value of U.S. assets.
Gourinchas and Rey said that the U.S. position at the center of the system gave it what they called an "exorbitant privilege"... The exorbitant privilege, Rey and Gourinchas explained, came about because the United States could borrow at a discount on world financial markets and get high yields on its external assets. They tracked how the United States had gradually taken on riskier overseas investments.
"Then we pushed these ideas further, by pointing out that the key role of the United States makes it also look very much like an insurer for the rest of the world," Rey explains. ...
Gourinchas said Washington has become more like the world's venture capitalist since the 1990s. "During the whole period, U.S. assets have shifted more and more out of long-term bank loans toward foreign direct investment (FDI) and, since the 1990s, toward FDI and equity. At the same time, its liabilities have remained dominated by bank loans, trade credit, and debt-that is, low-yield safe assets.
"Hence, the U.S. balance sheet resembled increasingly one of a venture capitalist with high-return risky investments on the asset side. Furthermore, its leverage ratio has increased sizably over time."
Rey says they expanded on this research during the global financial crisis, finding that the United States had reversed its role by channeling resources to the rest of the world through its external portfolio-on a large scale. "Our estimate is 13 to 14 percent of U.S. GDP in 2008 alone. So that was very significant."
The United States was providing "some sort of global insurance to the world economy and the rest of the world-earning the equivalent of an insurance premium in good times and paying out in bad times. And that's exactly what we see in the data."
"While the United States enjoys an exorbitant privilege on one side," says Rey, "it also, as global insurer, has an exorbitant duty in time of crisis on the other."

George H. Blackford said...

"For example, almost all U.S. foreign liabilities are in dollars, whereas approximately 70 percent of U.S. foreign assets are in other currencies. So a 10 percent depreciation of the dollar increases the value of foreign assets and represents a transfer of about 5.9 percent of U.S. GDP from the rest of the world to the United States. For comparison, the trade deficit on goods and services in 2004 was 5.3 percent of GDP. So these capital gains can be very large."

My problem is that, in the process, they closed all of the factory complexes in Flint, Michigan except one, and I don't own any of the foreign assets that are going to appreciate if and when the dollar depreciates.

Stock Market Valuation Exceeds Its Components' Actual Value

Slashdot

  • Stock valuations are based not only on actual assets, but future growth and earnings potential. If I buy company X, it's because I think company X has a good product, business plan, and management and is going to be able to grow faster than inflation and faster than their competitors. I certainly don't want them to liquidate their current assets and give me my money back.

    Reply to This Share

    twitter facebook linkedin Share on Google+

    Flag as Inappropriate

    • Re: (Score:3)

      by (630) writes:

      Yeah, we're done with this article.

        • Re: (Score:2)

          by creimer (824291) writes:

          If you're worry about your money being inflated away, convert your fiat currency into precious metals like silver and gold.

          • Re:And OP is retarded. (Score:5, Insightful)

            by Culture20 (968837) writes: on Monday May 18, 2015 @12:33PM (#49719145)

            Precious metals are only worth something because other people want them. Because they think the metals are worth something because other people want the metals because they think they're worth something because... They're pretty, they're partly lasting and they're rare. Until they're not: aluminum used to be a valuable metal. Now I coat my armpits with it every morning, and half the metal objects I own are aluminum.
            If you're expecting a big crash, you're better off purchasing items of utility or improving your land for raising food.

            Reply to This Parent Share

            twitter facebook linkedin Share on Google+

            Flag as Inappropriate
            • Re: (Score:2, Informative)

              by creimer (824291) writes:

              Never mind that gold and silver were used as money for thousands of years before the printing press made it possible to issue fiat currency.

              • Re: (Score:3)

                by Enry (630) writes:

                So were rocks and salt. Your point?

              • Re: (Score:3)

                by AthanasiusKircher (1333179) writes:

                Never mind that gold and silver were used as money for thousands of years before the printing press made it possible to issue fiat currency.

                Nonsense. Gold and silver can be "fiat" currency just as paper money can be. Fiat currency just means that a currency derives part of its value from the government's declaration that it shall function as a currency.

                For example, the U.S. government says that the "dollar" must be used to pay taxes. It could equally say that "gold" must be used to pay taxes, in which case gold's price would probably go up, since it would be more useful to pay for things with. That addition in value due to the government'

          • Re:And OP is retarded. (Score:5, Informative)

            by Sique (173459) writes: on Monday May 18, 2015 @12:58PM (#49719331) Homepage

            The volatility of precious metals is known since the Ancient times. Precious metals have never been a good storage for monetary value, their main advantage was their ability to be measured easily (either by weighing them or by counting minted coins), and to be carried around easily - advantages you also have with paper money or with the numbers on a banking account.

            Compare for instance the prices for platinum and gold, two precious metals with very similar properties: Same frequency of occurrence in the Earth crust, same properties (density between 19-20 g per cubic centimeter, does not oxydate easily, can be cast and cold formed), same usages (mainly jewelry, some industrial usage, some coined or cast into bars to be stored as assets). Their prices have been so volatile recently, that platinum was about twice the price of gold, and vice versa within just a decade. Compared with that, the dollar/euro exchange rate is an example of long time stability.

          • Re:And OP is retarded. (Score:5, Interesting)

            by rwa2 (4391) * writes: on Monday May 18, 2015 @12:36PM (#49719179) Homepage Journal

            All those things used to be "the conventional wisdom", but nowadays all of those things have been proven to be quite volatile.

            I never believed in "making money from money"... I guess that's called "financial engineering" nowadays? That kinda insults me as an engineer, since we generally abide by physical laws. With financial laws, you're pretty much playing games using other people's rules.

            Other people who profess to love money above all else, and play the game to generate more money out of "nothing", and if you would just give them some of your money to play with, they'll help you "grow" your money too for a cut of the "take".

            But they don't add any value to the economy... they "multiply" it. And then they can just take "a little bit off the top", because no one will notice.

            I'd love to invest in actual production... you know, things that add value and subtract costs instead of just "multiply" monopoly money. What options are there for that kind of thing?

    • Price to book? (Score:5, Insightful)

      by goombah99 (560566) writes: on Monday May 18, 2015 @11:21AM (#49718511)

      How is Q different than the usual Price-to-Book ratio, which formally has the same english definition of the share price to the per-share Asset value of the company? The price-to-book value doesn't go below 1 usually because a leveraged buyout of the company could fund it self by selling off the pieces. The Q-value seems to define assets as replacement value which is unclear. Is replacement value to be taken as what the assets would trade for in their used shape, or what they would cost to buy new.

    • Re:Does not understand the market, obviously. (Score:4, Insightful)

      by ScentCone (795499) writes: on Monday May 18, 2015 @11:22AM (#49718527)

      Stock valuations are based not only on actual assets, but future growth and earnings potential. If I buy company X, it's because I think company X has a good product, business plan, and management and is going to be able to grow faster than inflation and faster than their competitors. I certainly don't want them to liquidate their current assets and give me my money back.

      You've missed an important detail. They're not comparing the stock valuation to the assets alone. They're comparing the stock valuation to what the company would sell for if purchased. When you sell a company, you're also selling the "good will" and other value inertia things like brand familiarity, the value that will come from having the company in the future, etc.


all of its own PCs. If that manufacturing asset is private, it won't show up in the totals. If it is public it will show up in the totals, but may be valued lower due to location or other factors. And finally, the efficiency of the asset to deliver more for less is not factored in. We should expect the trend to continue as lo


Re: Does not understand the market, obviously. (Score:5, Insightful)

by DrLang21 (900992) on Monday May 18, 2015 @02:38PM (#49720425)

When you sell a company, you're also selling the "good will" and other value inertia things like brand familiarity, the value that will come from having the company in the future, etc.

These days it is often far dumber than that. Unless a company is paying a dividend, the only value you have is what someone else is willing to pay for it. In the age of worshiping the Almighty Growth, dividend payouts are more scarce than they once were and you can't expect a fledgling company will ever pay out. Stocks like that are little more than trading cards. It's just a popularity contest slightly regulated by supply. Actual earnings reports in these cases are only meaningful in the sense that people make buying decisions based on them, but with them having no direct impact on actual value.

Re:Does not understand the market, obviously. (Score:4, Insightful)

by Marginal Coward (3557951) on Monday May 18, 2015 @11:40AM (#49718719)

Right. It's been rare in recent decades for even individual companies to sell for less than their asset value, for precisely the reason you mention: that nearly any functioning business is worth more than the sum of its assets. The canonical example is Coca-Cola (KO), which Yahoo Finance indicates is currently selling for a price-to-book ratio of 6.28 [yahoo.com]. Should we expect something like the Coca-Cola company, which has had a strong business for over a hundred years consisting of a brand name known worldwide, a worldwide distribution system, and of course its famous "secret formuler" to sell for just the price of its property, plant, and equipment? Of course, Coke is an extreme example, but it illustrates a point that could be made less emphatically for nearly any successful business.

Although I don't disagree that the market is fully valued or even over-valued at the moment, this single q statistic isn't any reason to panic. As indicated in TFS, it's attributable in large part to near-zero interest rates. With nowhere else to go to earn money, investors flock to the stock market. That certainly has some potential for inducing a bubble, but I don't think we're there yet. These extremely low interest rates can't last forever, but since they're controlled by policymakers who are keenly aware of the implication of raising them, no interest-hike-induced stock market panic is likely to ensue. So, move along Citizens.

Re:Print some bucks (Score:4, Interesting)

by jfengel (409917) on Monday May 18, 2015 @12:23PM (#49719071) Homepage Journal

Effectively, they have been. The Federal Reserve has been keeping interest rates at levels that should be causing significant inflation. The goal is to prevent a deflationary spiral by pumping up the money supply: when you can borrow lower than inflation, people should borrow and pay it back with tomorrow's less-valuable dollars.

They've been doing that for nearly a decade now, and it has successfully prevented the deflation, but it's a little baffling that it hasn't touched off more inflation than it has. The consumer confidence is hovering around 100, which should be a decent level for a stable economy. Unemployment is still higher than we'd like but it's well off the bust years.

My hypothesis is that people have gotten too used to boom economies. If people aren't getting triple-digit returns they don't want to invest. What we've got is a very stable economy, exactly the kind that people should be able to take risks in, but without a real estate boom or dotcom boom or other scheme to get people to dump their whole life savings and then borrow on margin, they just don't bother.

Stability means that those who have been left behind continue to be left behind. That's the worst thing that can be said about the economy. There just isn't an engine of growth.

There are a lot of other factors, I'm sure. Europe went mostly for less aggressive measures, and their economies haven't come out as well, meaning fewer markets there. China's growth has ceased to be ridiculous. Oil prices should have sparked some kind of boom, and I've got a nasty cynical feeling that Wall Street is ideologically predisposed not to invest in the emerging energies as much as they should.

But a lot of it is the catch-22 you mentioned. Consumers and investors each seem to be waiting for the other to go first. We've been technically out of recession for more than five years, and it's gotten past the point where the recovery could be called mere accounting. It's real. But America just hasn't gotten its feet back under it in the way that it usually does.

[Apr 10, 2015] 'The Floating Kilogram' The Editor of the Sun Talks About His New Book On the Dollar Crisis

The New York Sun

By DAWN BENNETT, Adapted From Financial Myth Busting | April 5, 2015

http://www.nysun.com/national/the-floating-kilogram-the-editor-of-the-sun-talks/89117/

The following is adapted from an interview by Dawn Bennett, host of the radio show "Financial Myth Busting," with the editor of The New York Sun, Seth Lipsky. The broadcast aired March 8:

* * *

Ms. Bennett: Seth Lipsky is the author of a book titled "The Floating Kilogram and Other Editorials on Money from The New York Sun." Before the Sun, he spent 20 years at the Wall Street Journal where he served on the editorial board and helped launch the Asian Wall Street Journal as well as the Wall Street Journal Europe. Recently, Seth authored a column in the New York Post titled "Why does the Federal Reserve Fear a Real Audit," which is a question much on my mind. Seth, welcome.

Mr. Lipsky: Thanks, Dawn. It's nice to be with you.

Ms. Bennett: To put it charitably, Janet Yellen appears to be very alarmed that some members of Congress want to conduct a comprehensive audit of the Federal Reserve for the first time since it was created. If the Federal Reserve is doing everything correctly, why should Mrs. Yellen be alarmed and what does she have to hide?

Mr. Lipsky: Well, that's a great question. The Federal Reserve is already audited, in the sense that an accountant comes in and goes over its books. But what the Congress is talking about is a much broader look by the Governmental Accountability Office of how the central bank forms our monetary policy and what its relations are with foreign banks. The Fed has been fighting this tooth and nail as an intrusion on its independence. What Congress knows is that the Constitution gave the monetary power precisely to Congress.

Congress has a constitutional obligation and power to establish the American monetary system and regulate it, to coin money, regulate its value and that of foreign coinage. This has become a big issue where we have not taken a really systematic look at how the Fed operates in the hundred years that it's been in existence. We're starting the second century, and there is growing sentiment in the Congress to take a look at this. The audit of the Fed measure passed the House as recently as of September by a vote of 333 to 92, with 109 Democrats joining the Republicans. So the Fed is certainly growing concerned.

Ms. Bennett: The only reason Janet Yellen has the power to coin money is because Congress delegated its own power to the Federal Reserve in 1913. Isn't congressional oversight of that power something that should be considered commonsensical by the Federal Reserve?

Mr. Lipsky: The Fed was created in 1913. The Coinage power was first acted on in 1792, and coinage was given not to any Federal Reserve but to the United States Mint. When the second central bank came up to the Supreme Court it was really the tax and the borrowing power that the courts were looking at when they okayed the authority of the central bank.

Ms. Bennett: We are all accountable to someone or something, so what is wrong about the Federal Reserve being accountable to Congress?

Mr. Lipsky: Nothing whatsoever. Even Chairman Yellen acknowledges that Congress has the power. She's just pleading and warning that it not interfere. Why is Congress growing concerned about this in the first place? It's because the Great Recession has lasted six years and we still do not feel like we've recovered. What is the Fed's role in this? Could the reason that the Great Recession lasted so long be attributable to monetary policy? The value of the dollar has been allowed to collapse below one 1,100th of an ounce of gold. It was a 265th of an ounce of gold when George W. Bush was sworn in. These are huge questions, and somebody needs to ask them.

Ms. Bennett: It is quite clear to me that the Federal Reserve doesn't want the rest of us to actually be able to see what they really up to. If we did know what they're doing, do you think most Americans would just want it shut down? To your point, since 1913, the dollar has actually lost over 97% of its purchasing power. And of course, the economy has been subjected to one painful depression and a series of what I call Fed-created recessions. Despite the poor track record, we continue to support them. At the end of the day, does it matter if we even have a Federal Reserve?

Mr. Lipsky: I think the monetary questions do matter to every American in all positions. My favorite statistic is that between 1947 and 1971 the average unemployment rate was below 5%. From 1971 until today it was above 6%. What happened in 1971, when the unemployment rate began souring? What happened is we abandoned the Bretton Woods Gold Exchange System, under which the dollar was linked to gold, and the money began flowing not in the productive enterprises, but into the money markets and hedge funds and all these sorts of things and not so much into the kind of investment that created the great industrial base in America.

Ms. Bennett: Let's talk about that type of investment. According to a government report I've read, the Federal Reserve made $16.1 trillion in loans to big banks during that financial crisis. In my opinion, [it once] created the dotcom bubble and the housing bubble. Now, I think it has created the financial bubble that our markets are experiencing.

Mr. Lipsky: Asset inflation. The debate over inflation is one of the most important debates in the country. The left wing likes to say there is no inflation, but the dollar is worth only a tiny amount of the constitutional specie, which is gold and silver, compared to what it used to be worth. This is what people feel when they hear the government say there's no inflation but they try to go to the grocery store and they spend $50 or $100 on a tiny plastic bag with a few items in it.

Ms. Bennett: Yes, I know shelf inflation is huge, but I want to talk about commodities for a bit. The Department of Justice has recently said again that they're going after the big banks that have been, on an ongoing and continuous basis, manipulating gold and silver. What are your thoughts on that? Will it work this time? And, if so, is there a simple solution to stop them from doing this? They seem to get their hands slapped, apologize, and then come back and do it again, and again.

Mr. Lipsky: The news that the Justice Department is looking at something like ten or twelve major banks for possibly rigging the price of gold broke the same week that Mrs. Yellen was up on Capitol Hill testifying against an audit of the Fed.

Ms. Bennett: That's right.

Mr. Lipsky: One of the questions that The New York Sun raised is what is she afraid of then? Is it the danger that the Fed has been meddling in the gold market the way the Justice Department is alleging commercial banks have been doing it? It's the Fed that regulates commercial banks after all. I don't want to carry that argument too far. I asked it then in an editorial more in the nature of a question. But there is a movement in Congress to open up what is called a Centennial Monetary Commission that after the first hundred years of the Fed, would just take a look at how the whole system is working.

We've been in a period of fiat money, meaning dollars that have no connection in law to any gold or silver or other constitutional money. We've been in a fiat system since 1971. Previously, our dollars were always defined in terms of gold and silver, suddenly they're not. The unemployment average is much higher; the bankruptcy rate is much higher; the inequality rate has been much higher since the mid 1970's. Could this be related to the fact that we abandoned sound money in the mid 1970s?

Ms. Bennett: De-dollarization has been going on now for the last few years, and I think it's because the dollar is continuing to get weaker. Our political system and economic system aren't what they used to be. Do you think it's possible that if China, for example, standardizes the renminbi it will start taking power away from the U.S. dollar?

Mr. Lipsky: The abandonment of sound money by the U.S. has brought forth a whole chain of foreign governments that are alarmed and wonder whether a new system should be set up. China. There is talk of Russia going on a gold standard; the European Union is having its own catastrophe with the Euro, and it's wondering whether the dollar ought to be replaced as the international reserve. The United Nations, for crying out loud, has gotten involved in this.

One of my favorite moments happened in 1965, when the President of France, Charles de Gaulle, called a thousand reporters into the presidential palace sat them down and addressed them on the importance of restoring gold as the international standard. His argument was that it puts all countries on the same basis: America, France, England, China, little countries, and it takes a lot of the partisanship out of the monetary question internationally, or it takes the politics out of money. It's ironic that Fed loves to talk about how we shouldn't politicize the monetary system. If one really wants to de-politicize the monetary system, restoring a gold standard or something like it is exactly the way to do it.

Ms. Bennett: Mrs. Yellen claims that opening the Fed to an outside audit would "politicize" - her word - monetary policy.

Mr. Lipsky: Right.

Ms. Bennett: Isn't it political when Senator Schumer, for example, tells her to keep rates low every time she testifies before the Senate Banking Committee? Isn't it already happening?

Mr. Lipsky: You're exactly right. Why is it always the conservatives that are doing the politicizing and not the liberals? The big politicization of monetary policy happened in 1978 with the passage of Humphrey-Hawkins, which said that the Fed has to have a second mandate of increasing the employment rate or decreasing unemployment, in addition to affecting the value of our dollar. That opened the door to an enormous political interference in monetary policy.

Ms. Bennett: I know you're not a gold trader or silver trader...

Mr. Lipsky: I'm a newspaperman.

Ms. Bennett: There you go. But I'm certain you follow the markets. What do you think would be a simple solution to fix the ongoing and continuous manipulation of gold and silver so that we can get more stability? It does seem, whether it's a Federal Reserve or some other central bank, that they're interfering with it in order to make the fiat currency look stronger than it really is.

Mr. Lipsky: I favor a definition by law, enacted by Congress under its constitutional powers to coin money and regulate its value, and fix the standards of weights and measures - a law passed by Congress defining the dollar as a fixed amount of gold or silver. Silver was the main specie used in early years of our republic. The debate over whether gold or silver was better went on through the 19th century, and we basically decided in 1900, with the passage of the Gold Standard Act, to make gold the true national money. I think that would go a long way toward solving this problem. There are a lot of questions as to exactly how to do it, whether there should be a system like Bretton Woods, which said dollars had to be redeemed in gold if they were held by foreign governments.

Ms. Bennett: In physical gold, not paper gold. In physical gold.

Mr. Lipsky: Right.

Ms. Bennett: There's a big difference there.

Mr. Lipsky: Therefore the price at which one fixes the dollar, the value, the amount of gold, has to be carefully worked out. But the gold standard is not some flaky thing. This was believed in by George Washington, Thomas Jefferson, James Madison, Alexander Hamilton, and almost every president since, up until Richard Nixon. John Kennedy, Woodrow Wilson, Grover Cleveland - they all believed in it.

Ms. Bennett: Seth, "The Floating Kilogram and other Essays on Money from The New York Sun." For any listeners not familiar with the Sun, can you bring them up to speed?

Mr. Lipsky: The New York Sun is an online newspaper that I edit. We published in print until several years ago. It's a leading voice in journalism for a sound dollar. It supports a sound dollar, limited government, and a restoration of constitutional dollar based on gold or silver. This is the first radio interview about the book.

Ms. Bennett: Thank you.

Mr. Lipsky: This book contains on this issue 130 editorials that have been issued in the Sun in recent years. Steve Forbes calls them "brilliant," "irrefutable," and "the Federalist Papers for the gold standard." James Grant calls the book both "persuasive" and "unfailingly entertaining." It's a book for every person, not just the experts, and it's available on Amazon.com, the online bookstore, and you'll have a copy in a day or two if you place your order. "Pure gold" is the way the economist Judy Shelton described this book. The title, Dawn, comes from the discovery that the kilogram, which is the last metric weight measure based on a physical object, has been losing mass - atom by atom. The Sun in one of its editorials said, "Why don't we float the kilogram just like we float the dollar?" That's from where the title of the book comes.

Ms. Bennett: If President Obama, or our next president, were to become motivated to make reforms, what do you think the takeaway from this book would to be? Definitely a gold standard?

Mr. Lipsky: So I think the takeaway is going to be that in our monetary system at some point, the dollar has to be defined in terms of something real rather than just another dollar. At the moment, if you take your dollar to the central bank to redeem it, they'll give you another dollar. There's no reference to anything real and no classical measure of value. We have what Jim Grant likes to call the Ph.D. standard, and I think we need to move away from that to the kind of standard that sustained our country during its periods of greatest growth and strongest employment.

Ms. Bennett: We always seem to make changes in the United States when things break down, but not beforehand. What is going to be the instigator to standardize our currency?

Mr. Lipsky: People say things could become a disaster. The last six years have been a disaster.

Ms. Bennett: Exactly.

Mr. Lipsky: Huge amounts of unemployment, not just for a short period, but for six years. It's consumed almost the entire Obama presidency. People are still trying to figure out their homes, still trying to figure out how the price of college got more than halfway to $100,000 a year - you know, all these things. We've been living through this, and I think events have energized Congress to start looking at this. The Sound Dollar Act, or Centennial Monetary Commission Act, or Audit the Fed Act, or Free Competition in Currency Act. This is why Janet Yellen - to bring it back to where we came in - is fighting so hard against the Congress doing this. We're in a constitutional moment here where Congress is going to take a look at this, I predict.

Ms. Bennett: Do you think they're going to have the guts to do it?

Mr. Lipsky: I think the American people have a lot of guts.

Ms. Bennett: Me, too.

Mr. Lipsky: And at the end of the day, the Congress has to listen to the American people.

[Apr 09, 2015] Notes on the Currency War - 'Old as Babylon and Evil as Hell'

Jesse's Café Américain

Below is an excerpt from a much longer article which you can read in its entirety here.

It is an interpretation told from a certain perspective, but overall does a fairly decent job of laying out the general boundaries for the currency war that has been brewing in the background since 1971 with the collapse of Bretton Woods.

It is more visible to us now because it started manifesting more overtly in the 1990's and since then has slowly been gaining momentum.

If an analyst does not understand this, even if they do not agree with this particular interpretation, then they have a poor grasp of the major trends that are driving so much financial and political activity in the world today.

And fortunately or unfortunately, gold and silver are deeply involved as the traditional supra-national world currencies.

To put the entire thing in a nutshell, in 1971 the US arbitrarily ended the Bretton Woods Agreement by closing the 'gold window,' and placed the world on an entirely fiat reserve currency which the US controlled. Since the US is making monetary policy to suit its own domestic agenda, and increasingly so over the past twenty years, the stresses that this creates in the world have become unacceptable to many other countries, some of which are in a position to push back against this.

This tension between the dollar and the rest of the world is either going to end in an acceptable and workable compromise, or will result in a split of the world into regions of power and financial influence, most likely three or four. This will be accompanied by conflict on all the usual levels: diplomatic, economic, and military. We are seeing this today.

Compromise is being thwarted by a neo-conservative, militaristic and nationalistic group in the States, with clients in other countries, that view an American hegemony as the natural and highly desirable outcome of the end of the Cold War. However, this is a patriotic cover story for what is essentially a bid for more money and power for a privileged few who have no patriotism and little decency, who serve only themselves and their patrons. To quote Edward Abbey, their motives are 'old as Babylon and evil as hell.'

Whether you agree with this or not does not matter so much, because it is very obvious to those in countries like the BRICs that this is the situation, and they are acting on this, and the US is reacting in response. But from reading the literature of the neoliberal economists and neoconservative politicians, it seems hard to come to any other conclusion based on facts and specific actions which have been taken by the US, the UK, Canada, Germany and Japan.

I do not think it is too much to say that we are experiencing a type of 'world war.' This seems to be the type of settling of differences and adjustments that follow major economics shifts, as we had seen in the first half of the 20th century.

"The Fed effectively acts as the world's central bank, but sets monetary policy only in its own interest. Under the pressure and the orders of financial oligopolies, it fixes interest rates and prints money to suit itself, sending economies across the globe into tailspins...

These policies aren't enacted with the express goal of kicking the global South in the stomach, but this outcome is a necessary and predictable result of the domination of the global financial order by a sole country whose interest is to keep its hegemonic status. Other measures are taken precisely toward this end. This latest round of financial warfare has to be seen in the context of financial imperialism in general. Countries struggling for sovereignty are also being hit by sanctions, speculative currency attacks, commodity price manipulation, biased evaluations from US ratings agencies, massive fines on some banks for what the US has deemed inappropriate practices, and the prohibition of certain banks from participating in the international banking system...

Not only does the dollar enable the US empire, but also protecting the dollar's status is a major reason for US imperial wars. American financial and military strength is based upon the fact that the dollar is the world's reserve and international trade currency, creating a global demand for dollars which allows the US to print as many greenbacks as it likes. It then pumps them into the overbloated finance capital system and uses them to fund its criminal wars...

Without this international demand for dollars, the dollar would "correct," and US hegemony would eventually, inevitably, come to an end. Therefore the US pressures and attacks countries that attempt to free themselves from the dollar's yoke, not only because they're guilty of lese majesty, but in order to force the world to maintain the status of the dollar and thus preserve US domination...

Although it has so far been unsuccessful, the idea of rebalancing the world monetary system is extremely threatening to the US, and goes a long way toward explaining recent US wars and warmongering, which may otherwise seem irrational...

The dollar is rallying less because of any supposed US recovery than because of higher global demand for dollars due to investors' risk aversion, in the wake of the Fed pulling the plug on QE. Parenthetically, the US economy is definitely not recovering...

While a stronger dollar will not hurt the consumption-based US economy, the rising dollar and US monetary tightening are about to give the developing world a severe blow..."

Michèle Brand and Rémy Herrera, Dollar Imperialism 2015

"Plunderers of the world, when nothing remains on the lands to which they have laid waste by wanton thievery, they search out across the seas. The wealth of another region excites their greed; and if it is weak, their lust for power as well.

Nothing from the rising to the setting of the sun is enough for them. Among all others only they are compelled to attack the poor as well as the rich. Robbery, rape, and slaughter they falsely call empire; and where they make a desert, they call it peace."

Tacitus, Agricola

Ben Bernanke Was Right No Rate Normalization During My Lifetime

Zero Hedge

With the Fed's credibility terminally smeared across the windshield of the Marriner Eccles-mobile, courtesy of the latest "dots" projection which proved yet again - and beyond any doubt - that the FOMC members are just a pack of chimps throwing darts, and perhaps feces, at a fed funds dart board, we can now honestly say that the one Fed (ex) member who was 100% accurate (if only in this case), and who saw the writing on the wall early on and got the hell out of Marriner Eccles while he could, is Ben Bernanke.

As a reminder, this is what he said (via Reuters):

"At least one guest left a New York restaurant with the impression Bernanke, 60, does not expect the federal funds rate, the Fed's main benchmark interest rate, to rise back to its long-term average of around 4 percent in Bernanke's lifetime. "Shocking when he said this," the guest scribbled in his notes. "Is that really true?" he scribbled at another point, according to the notes reviewed by Reuters."

Yes, it really is.

[Mar 20, 2015] Lenin Was Right...

Mar 18, 2015 | Zero Hedge

Bear Markets Do Happen

Today… the second of the speech about the end of the world we recently gave at Doug Casey's La Estancia de Cafayate. (You can catch up on the first part here.) As Yogi Berra would say, America is going to come to a fork in the road… and it's going to take it.

Right now, the Fed isn't as aggressive as the European Central Bank (which is set to pump €1.2 trillion into the financial markets by way of its QE program) or as innovative as the Bank of Japan (which is buying stock market funds as well as bonds by way of its QE).

Valuations are at extreme highs on Wall Street. Take Warren Buffett's favorite measure – market cap to GDP. With an eight-month exception at the height of the dot-com boom (and you know what happened next), the value of all outstanding S&P 500 shares is the highest it has been relative to US GDP in the last 100 years.

Meanwhile, Deutsche Bank is warning that S&P 500 earnings per share will be flat this year when compared with 2014. Retail sales are down about 9% on an annual basis over the past three months. And the US GDP has slowed to an annual rate of just over 1%… with the possibility of a surprise recession on the horizon. Besides, crashes and bear markets happen. This seems as good a time as any.

Buffett-Indicator

Market cap to GDP a.k.a. the "Buffett Indicator", via Doug Short/Advisor Perspectives. Yes, the market does appear to be slightly overvalued … click to enlarge.

Deeper into the Heart of Darkness

When the next crisis comes, the fork in the road will be a choice. The Fed can either admit its policies have not worked… chuck them out… let interest rates settle where the market wants them to settle and let the free market do its work.

Or it can follow the Europeans and Japanese toward more aggressive intervention – including massive QE and direct stock buying. I don't think there's any doubt about what it will do: It will go deeper into that heart of darkness.

In fact, I believe central banks and central governments now have revealed the full madness of their intentions. Well, maybe not the full madness. They haven't thrown money from helicopters yet … but that will come.

Here's what's in the cards for central banks:

•They will set interest rates at preposterously low levels for years and years
•They will finance 100% of government deficits – forever, if it comes to that – with printing-press money.
•They will also pump up the stock market with this same money-from-nowhere by directly buying equities ETFs (as the Bank of Japan is already doing).

You'd have to be brain-dead (or a modern economist) not to be staggered by the audacity… the ballsy mendacity … and the incredibly big lie that undergirds the entire charade: that you can create money out of nothing and use it to pay for wars, schools, highways, and salaries for bureaucrats … and also to acquire real businesses.

We're with Lenin …

I recall Lenin's quote: "The capitalists will sell us the rope with which we will hang them."

Today, of course, the capitalists don't even sell the rope; they give it away, for nothing. But what's not to like? Stock investors are getting rich. Bondholders are making money. The government can spend as much as it likes. And the voters are bamboozled by it; they think it helps make the economy work better.

This is going to be a hard habit to break. So, here's the gist of my conclusion: Governments won't break the habit of getting something for nothing. It will break them. But how?

It looks as though they've got the perfect hustle going. They create money to buy their own debt. But this doesn't cause consumer prices to rise (at least how they're officially measured). Everybody's happy.

Obviously, that won't work forever. I don't care how many knobs you turn or how many levers you pull. It doesn't work that way. Ultimately, you're putting rusty nails on the ground… and you're going to step on them How? When?

Nobody knows. But I'm going to take a guess …

got rope

Rope comes for free these days … or at least the money to pay for it does.

Photo via twitter.com, source unknown

The Weakest Link

And here I'm no longer using my powers of observation to tell you what is going on. I'm using my intuition and guessing. The weakest link in the central bank chain, I believe, is credit. So let's look at how this link might break.

In our modern economy, when we talk about "money" what we are really talking about is credit. Banks create this credit ex nihilo (out of nothing) when they make a loan. It exists, for the most part, as a digital record on a computer network somewhere…

And unlike even traditional paper money, this credit can vanish as quickly and easily as it got here in the first place.

Because it is purely digital in nature, you can't hoard credit. You can't put it in your safe. You can't take a wheelbarrow full of it to the grocery store for a loaf of bread. Credit depends on trust. (The word "credit" comes from the Latin "credere" – to believe or trust.)

So, when our financial system implodes – which is what always happens when there is too much debt – the machinery of borrowing and lending will seize up. No one will trust that he will get paid. Credit will simply disappear – trillions of dollars of it – overnight.

This is, of course, not the end of the world. Nor even the beginning of the end. But it will be the end of the beginning of the paper money world President Nixon unwittingly created in 1971. Then the end can begin…

G-10-debt

Debt components to GDP, G-10 – click to enlarge.

Latina Lover

USSA , USSR, whats the difference?

[Mar 18, 2015] http://www.bbc.co.uk/news/business-31921011

bbc.co.uk

Warren , March 17, 2015 at 12:50 pm

France and Germany join UK in Asia bank membership

France and Germany are to join the UK in becoming members of a Chinese-led Asian development bank.

The finance ministries of both countries confirmed on Tuesday that they would be applying for membership of the Asian Infrastructure Investment Bank (AIIB).

Last week, the US issued a rare rebuke to the UK over its decision to become a member of the AIIB.

The US considers the AIIB a rival to the Western-dominated World Bank.

The UK was the first Western economy to apply for membership of the bank.

But German finance minister Wolfgang Schaeuble confirmed on Tuesday that his country would also be applying for membership.

France's finance ministry confirmed it would be joining the bank. It is believed Italy also intends to join.

The US has questioned the governance standards at the new institution, which is seen as spreading Chinese "soft power".

The AIIB, which was created in October by 21 countries, led by China, will fund Asian energy, transport and infrastructure projects.

When asked about the US rebuke last week, a spokesman for Prime Minister David Cameron said: "There will be times when we take a different approach."

The UK insisted it would insist on the bank's adherence to strict banking and oversight procedures.

"We think that it's in the UK's national interest," Mr Cameron's spokesperson added.

'Not normal'

Last week, Pippa Malmgren, a former economic adviser to US President George W Bush, told the BBC that the public chastisement from the US indicates the move might have come as a surprise.

"It's not normal for the United States to be publicly scolding the British," she said, adding that the US's focus on domestic affairs at the moment could have led to the oversight.

However, Mr Cameron's spokesperson said UK Chancellor George Osborne did discuss the measure with his US counterpart before announcing the move.

Some 21 nations came together last year to sign a memorandum for the bank's establishment, including Singapore, India and Thailand.

But in November last year, Australia's Prime Minister Tony Abbott offered lukewarm support to the AIIB and said its actions must be transparent.

US President Barack Obama, who met Mr Abbott on the sidelines of a Beijing summit last year, agreed the bank had to be transparent, accountable and truly multilateral.

"Those are the same rules by which the World Bank or IMF [International Monetary Fund] or Asian Development Bank or any other international institution needs to abide by," Mr Obama said at the time.

http://www.bbc.co.uk/news/business-31921011

marknesop , March 17, 2015 at 3:11 pm
The USA's grip on Europe, against all odds, is loosening. Who would have thought it would be over money, considering it went meekly along hand-in-hand with Washington in imposing sanctions which had an immediate and deleterious effect on its bottom line? I mean, isn't that money, too?

"The UK insisted it would insist on the bank's adherence to strict banking and oversight procedures. 'We think that it's in the UK's national interest,' Mr Cameron's spokesperson added." Hahahahahahahahahahahahahahah…Oh, 'pon my word, yes, m'lud. The UK would be everyone's first choice to monitor strict adherence to banking and oversight procedures, after the £2.7 Billion in fines handed the Bank of England for currency rigging – which also resulted in the dismissal of its senior foreign exchange dealer – just a few months ago. Or the Payment Protection Insurance (PPI) scam, in which banks greedy for more profit conspired to rig the deck so that insurance which cost more and more stood less and less chance of ever having a successful claim levied against it. And let's not even mention Libor.

I don't think there's too much about crooked banking the Chinese will be able to teach the British.

james, March 17, 2015 at 3:59 pm
there is a straight line that runs from the boe to the federal reserve… moon of alabama has a post up discussing some of the changes afloat which can be read here –

http://www.moonofalabama.org/2015/03/the-end-of-the-us-dominated-international-money-system.html#comments

davidt, March 17, 2015 at 3:14 pm
My favorite Czech, Vlad Sobell, has an new article "The opportunity cost of America's disastrous foreign policy", which most of us here would agree with:

http://russia-insider.com/en/2015/03/17/4594

He reminds us what could have been if Putin's vision for creating a huge harmonized economic area stretching from Lisbon to Vladivostok had been realized. (George Friedman has already explained why this could not be allowed.)
I don't think that anyone has mentioned an earlier article by Sobell that appeared as his contribution on the experts' panel on us-russia.org, His is the last contribution.

http://us-russia.org/2982-why-the-minsk-2-settlement-of-the-ukrainian-crisis-will-hold.html

If there were an award for clear thinking then Sobell would have to be a prime candidate.

kat kan , March 17, 2015 at 5:14 pm
Only problem is, this was written in February. And without regard for Poroshenko.

The weapons withdrawals were more or less done. Nothing else was. The Special Status law proposal was based on September lines and not discussed with the Republics so is unacceptable to them. Not only was there no improvement of humanitarian access, but it has been tightened up, to the extent that virtually no medicines are getting through, and no food at all. Travel to and from the Republics involves permits that take 3 weeks to get. The gas got cut off once. No social payments have been made and no wages back-paid. All this is in Minsk2 and Kiev's actually gone backwards on these clauses.

The reality is, Minsk2 will not succeed, because Kiev (and their masters) don't want it to. Poroshenko is carrying in like he can set conditions, as if HE HAD WON when in fact HE LOST.

davidt , March 17, 2015 at 6:17 pm
From memory, I think that Sobell would agree with your penultimate sentence- I don't think that he was very optimistic about Minsk2. (On the positive side, the gap between Europe and the US seems to have hardened.)

[Feb 27, 2015] Currency Wars

12 February 2015
"As a delaying tactic, U.S. foreign exchange operations were often successful. They raised the potential costs of speculation and provided cover for unwanted, temporary, and ultimately reversible dollar flows. They delayed the drain of the U.S. gold stock. But to the extent that these devises substituted for more fundamental and necessary adjustments and postponed the inevitable collapse of Bretton Woods, they were a failure."

Robert Wenzel, Cleveland Fed Accidentally Links to Paper Highly Critical of US Currency Market Interventions to Support Bretton Woods

When I said, and it already seems so long ago, that we had broken out with a higher high a few weeks ago, I cautioned that the markets had not suddenly become honest and transparent. and so caution was still advised.

And indeed, the breakout was stuffed, by the usual routine of dumping large amount of futures contracts at the market in thin trading hours, often on the open of the NY trading.

This is the currency war. This is the struggle we are seeing for the nations of the world to find a new way of arranging their international trading relationships. This is the fruit of Triffin's Dilemma, which suggests that at some point if a single country manages the world's reserve currency, eventually they will come to an impasse between their domestic interests and the interests of the rest of the world.

And after the failure of Bretton Woods, and the slowly destabilization of Bretton Woods II, we are now at a time of reckoning.

Some mistakenly think the dollar is rising now because of Triffin's dilemma. This is really not the case, but rather a temporary policy choice by the US to allow the dollar to appreciate against the euro and the yen. Remembering that the US Dollar DX index is weighted to a certain group of currencies that reflects how things were earlier in the last century.

The US is fostering the myth that it is already past the worst of the financial crisis. A crisis, I might add, which its Banks largely promoted through their frauds, and the abuse of the dollar's reserve currency status with the cooperation of the Federal Reserve and acquiescence of the regulators.

This transition is not going to be short, nor easy. And as for the precious metals, I have rarely seen so many who are so discouraged. They hear and see so many conflicting things that they do not know what to believe.

And losing money hurts, ESPECIALLY if you are using leverage and are overextended. Mining companies are levered plays on the precious metals, and the smaller the cap, the greater the leverage.

Timeframes also matter. I have been in this metals trade for a long time, but not because I like gold for itself. When I was looking seriously into international money issues and global trade, which was related to the communications business I was in, I came to believe that we were approaching a currency wars scenario.

It seemed pretty clear that the Dollar regime could not be sustained without the establishment of a very unipolar, de facto world governance, with perhaps two or three cooperating spheres of control. I had written a paper about this in B-School in 1991 (ok I was a late bloomer but as an classically educated engineering type pure business management course were not my thing). But my thinking really did not become firm enough to take action until around 2001.

And there is clearly a movement in the direction of a unipolar world, from the neo-cons and their associates. Money is power, and power is the new god of the marketplace in the West, if not everywhere.

So try to keep this in perspective. These are very difficult times for those seeking safe havens. A major supplier of retail precious metals is publicly referring to a large number of their customers as 'crazy' even while there is a sea-change with central banks increasing their gold reserves (although it is clear the WGC is a bit blinded to China). Fed President Richard Fisher owns quite a bit of gold. Maybe he is crazy too.

I remember, quite vividly, gold being at $280 and silver at $4.70 and the prevailing wisdom amongst almost all the traders I knew was that the precious metals were 'dead money.' Seriously. You could barely find a buyer less than 20 years ago.

The truly big changes catch people flat-footed, because they run against the grain of what we knew yesterday. Most people are focused on the short term and the markets especially have come to take a very short term speculative bias.

I do not know what will happen in the future, and do not think for a minute that I do. We are all in God's hands. But I am looking for any signs, based on my understanding of how certain things work, and over a 20 year timeframe it is pretty much on track.

Don't be overly worried about these things that are beyond your control, or so fearful that you become preoccupied and distracted from your responsibilities and a righteous path. Rather, spend more of your time on things that you can control, and the things that will, in your waning days, loom most heavily on your conscience.

Have a pleasant evening.

[Jan 25, 2015] Within an individual economy fiat money has the enormous and – I think – key advantage of allowing for counter-cyclical fiscal policy

Tim Owen, January 25, 2015 at 3:54 pm

Funnily enough the IMF itself has admitted in its laconic way that austerity doesn't work:

http://www.theguardian.com/business/2013/jun/05/imf-underestimated-damage-austerity-would-do-to-greece

So I expect them to come out with a ringing endorsement of the new government.

..james, January 25, 2015 at 4:55 pm

the imf is a front for western banks giving loans to countries that typically can't pay the money back! what is there for western, mostly wall st banks to not like about that! they especially like the gaurantees that come with these imf rbber stamped loans! it is about lending mone, the great ponzi scheme of the fiat system… don't pay it back, just keep these interest fees or usury fees flowing endlessly!

Oddlots, January 25, 2015 at 6:06 pm

(Roughly) Correct!

Syriza Wins and the NYT and WSJ Coverage Competes for Mendacity

http://neweconomicperspectives.org/2015/01/syriza-wins-nyt-wsj-coverage-competes-mendacity.html

"The Wall Street Journal and the New York Time's eurozone reporters, who share the same unshakable devotion to TINA and austerity as the Murdochized WSJ news staff have been thrown into a panic by Syriza's electoral successes in Greece.

Both papers are freaked out, as are the Germans, about the potential for Greece to spark a wave of rejections of the troika's infliction of austerity in a manner similar to how the infliction of self-destructive austerity programs pursuant to the Washington Consensus' demands led to the "lost decade" and the democratic election of what is now over a dozen Latin American candidates running on anti-austerity platforms. The Washington Consensus was drafted and named by an economist at Pete Peterson's International Institute. Peterson is a Wall Street billionaire whose mission is causing debt and deficit hysteria and plugging the joys of austerity and unraveling the safety nets. His greatest goal is privatizing Social Security – producing hundreds of billions in additional fees for Wall Street."

It's actually kind of funny. Everyone seriously engaged with the Eurozone crisis agrees that austerity hasn't worked but the one thing that terrifies them most is ending it. All bow down before that display of European deep thinking.

Where I'd disagree with you is this: I don't think that these are attributes of "fiat" money per se. Within an individual economy fiat money has the enormous and – I think – key advantage of allowing for counter-cyclical fiscal policy. It gets a little more complicated when you are talking about a community of economies and trade, but the basic dynamic is the same: the hallmark of a true capitalist economy is credit cycles creating booms and busts. The only practical monetary system is one that can counteract the busts, lest they be (needlessly) fatal. And the only system that meets that description is fiat currency.

FWIW under a fiat regime it's impossible to "pay" all the debt back. The reason is kind of depressingly simple: because if we did there wouldn't be any money in circulation. Suggests to me that we need some new word to describe government debt to indicate that there is NO effective similarity between a household "budget" and the budget of a sovereign government that issues its own currency.

Oddlots , January 25, 2015 at 6:09 pm

PS, if I wasn't clear I'm not really expecting a ringing endorsement from the IMF despite the white papers.

james@wpc , January 25, 2015 at 8:08 pm

I agree with Oddlots in that the problem is not the currency being a fiat one. The problem is that the fiat currency is issued by private bankers who regulate the amount of the money supply to their own advantage creating endless cycles of boom and bust.

The simple but seemingly impossible answer is a representative government that issues their own fiat currency and regulates it for the benefit of the general population and thus ensuring steadily growing living standards. Mind you, govts that have done just that, such as Libya, Syria, Iran, China and to some extent Russia, have found themselves facing invasions or threats of invasions.

"Austerity" is never designed to work as advertised. It is designed to impoverish people to make them more malleable and controllable. Austerity defies basic economic principles and even common sense.

I don't hold out much hope for change with the new Greek govt. They have committed to remaining in the EuroZone and will refinance the IMF loans which means more interest for nothing. This doesn't sound at all radical to me.

More likely is that the Greek population has been conned again and the WSJ et al are playing along with the faux opposition meme. We'll know soon enough.

[Sep 28, 2014] It May Be Protracted, But It Is an Endgame Nonetheless

Jesse's Café Américain

One of the more significant things that I have seen so far this year is independent confirmation from a credible source that there is price rigging in the silver markets, and that this knowledge is being suppressed by the mainstream media in the US.

You can read about that here.

I think the fact, given all the rigging scandals from Madoff to LIBOR, that there are major mainstream publications which will refuse to run an article showing evidence of rigging in the silver markets from a credible source is probably as profound as the report itself might be. They know what is happening, and they are afraid.

So what does this imply.

It implies that powerful financial interests are engaged in an attempt to manipulate the value of certain precious metals to artificial targets. They frequently do this with certain things we know.

Dollars and bonds are amenable to this sort of financial engineering, because the financiers are able to create enormous amounts of money using their balance sheets, and with it buy bonds and other financial paper. So they can raise and lower interest rates and other benchmarks at will provided that they can do it in secret and with plausible deniability.

They can rig LIBOR, and the ISDAFix, and any number of benchmarks, because these are creatures of their system, without a hard reference or a firm anchor to anything in the real world. LIBOR and the amount of money they have in their vaults can be almost whatever they wish them to be, as long as the people believe.

Their nemesis, however, is when they foolishly tie themselves to something external, something that is beyond their system. Their error is when they overreach, and try to extend the mythology of their price fixing to things that are not completely under their control for any longer period of time.

Gold and silver are two such things. Yes, they can engage in all sort of gimmickry on their own exchanges where they make the rules and keep the records. Paper and paper money can symbolically represent precious metals both in quantity and value. Tonnes of imaginary and hypothecated ounces of bullion may be traded all day long, but without requiring a single physical ounce of gold or silver having to change hands. The pricing has been divorced from the constraints of supply and demand. As always, the devil is in the leverage.

Longer term of course there will be effects, very powerful effects. The amount of actual gold and silver that is represented by their paper continues to dwindle, increasing leverage. Physical bullion will flee their system, as it is doing already. That which is unmined will be left in the ground. This is Gresham's Law in action. The 'bad money' will drive out the good.

And they are foolish! There is no real civic need for them to have done this. What does it matter if gold and silver are priced at 1200$ or 3200$ as long as the price increase is orderly and not a panic? All sound economic theory suggests that as the price of gold and silver increase, economic activity will increase to make more supply available. People might choose it as a store of value, or not. It has its advantages and disadvantages, depending on the context of its environment.

You can say that this would cast doubts on the value of the financiers paper, but again, not in any practical sense as long as supply of metal was not constrained and the supply of money was not expanded recklessly without reference to the productive economy. Even Greenspan admitted this.

By aggressively seeking to manage the price of the metals, by continuing to press their leverage and their perceived successes, the Banks have created a façade and blindly run to the precipice of an inevitable reckoning, as the London Gold Pool had done in the early 1970's.

The BRICS see this hubris, like the traders who saw the folly of attempting to hold the British Pound to an untenable valuation. And they will continue to keep pounding the Banks' positions with their trades, accumulating more and more of their physical metals, until the trade is unwound, or a failure comes to stand and deliver.

This is what I think is happening. I do not think a serious market failure is inevitable. But a better outcome would require a level of humility, wisdom, and self-awareness of which our ruling class may longer capable.

Wall Street has become maddened with greed. And by stifling all criticism and dissent, their enablers have only enabled them to go further and further, until the point of no return is reached.

We observers are almost like Harry Markopolos, who wrote of his frustration in Madoff: No One Would Listen. We are like those who warned of the growing housing bubble, and took steps to protect ourselves from it.

We only need to abide, and if we can abide, then we will prevail. Their schemes will eventually fail And in that failure there is both risk, and opportunity.

Have a pleasant weekend.

[Feb 07, 2014] Investment and Insurance: Prospective Risk and Return in Various Precious Metal Investments

Jesse's Café Américain

To buy, or not to buy? Allocated, unallocated, or exchange-traded, derivative, or nothing? That is the question.

"Simply, antifragility is defined as a convex response to a stressor or source of harm (for some range of variation), leading to a positive sensitivity to increase in volatility (or variability, stress, dispersion of outcomes, or uncertainty, what is grouped under the designation "disorder cluster").

Likewise fragility is defined as a concave sensitivity to stressors, leading a negative sensitivity to increase in volatility. The relation between fragility, convexity, and sensitivity to disorder is mathematical, obtained by theorem, not derived from empirical data mining or some historical narrative. It is a priori".

Nassim Taleb, Mathematical Definition, Mapping, and Detection of (Anti)Fragility


Yes, I know, there is a certain fiendish humour as Taleb introduces this quotation with 'simply' and then goes on to use enough jargon to make the layperson's eye glaze over.

But what Taleb is describing here is a fundamental that many have forgotten. It is the corollary to his more famous observation about 'black swans' and 'tail risks.'

What Taleb is basically saying is that a system or investment that is designed to accommodate infrequent but outsized and somewhat unpredictable risks performs one way he calls anti-fragile. And other systems and investments are designed so that they perform well under 'normal conditions' but tend to underperform, and often badly, during the unexpected.

Here is my own picture of Taleb's concept of how investments react. It might not be exactly what Taleb himself has in mind, but it something I had thought of for other types of information systems in a prior occupation, and is how I remember it for my own purposes:


If you want to grossly oversimplify this principle, remember the saying, pick the right tool for the right job, and remember that nothing comes for free. I used this in describing tradeoffs in very complex products and networks, and while it may sound trite, it worked with a lot of upper level executives.

But what is the job itself? Well, the application defines it of course. But one must also take performance criteria into account, and with performance there are environmental conditions and variabilities. Would you like to have a network that can function for your casual use in your home, or a high performance network that can survive arctic cold and desert heat.

Don't laugh. I used to drop networks into some of the more out of the way and volatile places around the world, put electronic equipment in explosive environments, and met application criteria that had many other product managers running out of the room screaming for momma. It was my particular competitive edge. It only comes with experience, confidence, and a fanatical understanding of the odds and how they can mount against you.

But you don't want to waste money and over engineer something either. That is a good way to go broke. But you need to understand expected performance, and the risk profiles for just about anything that is not merely incidental.

And if there is anything that I wish you to remember from this blog, after all these years, it is the deadly trap of undisclosed risks and the tendency of some to understate those risks for their own short term advantages. And how other people will go along with them. In a nutshell, this is the story of our last couple of financial crises.

It is far too complicated to get into this afternoon, but lets just say that a number of mathematicians and industry analysts, among them Taleb, Mandelbrot, Tavakoli, William Black, Yves Smith et al., that there was significant undisclosed risk in the system because models (Black-Scholes for example) greatly simplified the risks, and assumed distributions of variability that were not real world realistic.

If you wish to read more about this in more detail Benoit Mandelbrot's book, The (Mis)Behaviour of Markets, is readable enough while containing enough substance to chew on. I enjoyed it because of the way he demolishes the efficient markets theory and other vain imagining, as I cannot resist a bit of schadenfreude now and then.

There was a movement in finance to force normal distributions onto data that did not really justify it. In order to achieve this, the risk models made certain assumptions, and thereby 'flattened' reality in order to fit the model. What one ended up with was a mis-estimation of the risk probabilities. And so we saw 'once in a hundred year events' happening with alarming frequency, despite the best efforts of the financial planners to smooth them over with piles of bailout money.

Here is a picture of what such a discrepancy might look like:


So the financial system designer likes the normal distribution and makes their operational plans based on that. But why is this? Are they diabolical fiends? Do they enjoy screwing up?

No, they are ordinary people for the most part, but following orders. And the orders are sometimes to take the faux normal approach because it costs less to implement, allows for greater leverage, and fattens profits, at least in the short term. Many a compliance officer and systems engineer has fallen into this trap.

Careerism's second law is if you are wrong with everyone else, no one can blame you. And so many financial myths have thereby obtained extended lives, because they provided a fig leaf for someone's self serving ends. This is in some ways the story behind the failure of our regulatory systems, often staffed by good people but who are underpaid, overworked, and subject to extraordinary political pressure to turn a blind eye to what otherwise might provoke their action. Especially where there is a lack of complete certainty, which is all too often the case in real life.

So what is the punch line. If you are buying an investment as a safe haven, something that will perform well in a difficult and somewhat unpredictable circumstance, you will wish to take your money into something that is highly transparent, robust made to endure the unexpected, given too few assumptions, and perhaps even strongly guaranteed.

And if you are not, if you wish to invest in something with a decent return, but in your own estimation performs adequately for your own time horizons and expectations, then pick the product in which you have confidence, provided it meets your needs and provides some advantages in features and price.

I am not going to talk around this much more, since I am obviously talking about the pros and cons of certain types of gold and silver investments versus others. And those pros and cons are ALWAYS going to be affected by how you perceive the risks, and how that investment fits into your plans. This is a given. And this is why I would never give anyone advice, because I am not a financial advisor and do not have the 'big picture' of what they own particular situation, their goals and time horizons, might be.

I will use myself as an example. I tend to gravitate a portion of my portfolio into very certain gold and silver investments, where I have a very high confidence in them based on audits, ownerships, and so forth. There is not much about them I do not know and have to assume. Yes there are the really wide outliers like a meteor hitting the earth and bringing on Mad Max and cyclist cannibals, and I might drop a dime or two on arms and infrastructure just for grins, but by and large I think I can ignore that for now.

But for the most part a failure in the financial system that could be adverse to my wealth seems a little more likely. And so part of my portfolio is in highly secure investments that will benefit from disorder and give me a premium on return that will cover losses elsewhere.

And other parts of my portfolio are in investments that are more fragile as Taleb would say. But they provide a nicer short term return with less expense. And there is nothing wrong with this. Not at all.

By the way, and I hate to even bring it up, but gold and silver themselves suit slightly different purposes. Silver is less 'anti-fragile' than gold in dire circumstances, generally. But it offers some juicy upside in certain circumstances in compensation. And there are always special situations to consider, and for this I read guys like Ted Butler who track imbalances that could provide opportunities or risks.

I do not consider one or the other better; they are different. And I own both, and invest speculatively in both, at varying intensities depending on the changing context of the markets.

I would certainly buy some other financial instrument or stock I consider less robust for a quick flip or outsized return. The miners would fall into this sort of category. I am sure some of my bank accounts would as well, depending on how high the risks, And physical property is notoriously non-portable if you decide to take up roots and go to another place, which had been in my longer term plans, which were thwarted by an act of God and other considerations.

So, as far as unallocated gold goes, there is nothing inherently wrong with it. It is a very nice way to own gold with a reduction in expenses. I am sure not all providers of such a service are equally reliable, and their representatives would do well to discuss their own advantages, guarantees and superior performance as would any provider of products when faced with less reliable competitors.

I will say that deriding critics as loons and charlatans, and referring to a portion of your prospective clients and client influencer base in a generally derogatory manner with a pejorative nickname promulgated by economists who hate precious metals on principle, is probably not a high profile technique in the salesperson's handbook for success. Answer with facts. Once you descend to name calling you have lost. Just a word to the wise, and enough said about that.

Know why you are buying what you are buying, and how it fits into your overall scheme, and what assumptions you are using. And do not be afraid to have contingency plans and change them if new data comes your way.

I know it is hard, especially in times of currency wars, because the first victim in all war is the truth. But don't go off the deep end either, and waste your money on over complex plans or put all your eggs in an improbable basket. It's your call, and perhaps you need a professional to help sort out exactly what your priorities are.

I keep a spreadsheet, and on it there is a summary of all my assets, and it fits them into a simple risk portfolio so I can see how they are distributed by risk and by total value. Since the prices of things change, you have to be aware of how that affects your overall portfolio. I have to say that physical bullion has taken a much larger place in my overall profile since 2000. But that is fine, I just need to be aware of not letting it become a risk, and to balance it as required.

Would I buy GLD as 'insurance?' Hell no. Maybe as a flip investment on a technical trade. Would I buy some physical trust with strong outside auditing and redemption features? Probably, because it covers a bit of both insurance and investment. But it lacks the leverage of a small cap miner just for example. But it does not nearly have the risk.

Yes it is 'that simple.' Which is to say, it can be simple to understand but hard to implement. But you have to start somewhere, and if you start all wrong, it gets worse as you go. Some parts of my portfolio are for insurance, and other parts are for investment. They serve different purposes. I had the damnedest time trying to convince a broker at a white shoe firm who was managing my stock options portfolio of this. He thought I was schizoid. He only thought in terms of good stocks and great stocks. So I got rid of him, as he was too focused on his own goals, even when he feigned altruistic concern for my money.

And sad to say, for most people, their major task is just getting by day to day. And so the pros and cons of various investment techniques is so much hoohah because their most ambitious aspiration is to stay out of debt, especially usurious and fee laden debts, while putting a little bit aside. And this is why I spend quite a bit of time writing about these abuses, because I am not only a caterer to the elite, but to our little community which has a range of wonderful souls in it.

As always, the devil is in the details, but it helps if you know the lay of the land, and where you think you are heading, and why. And of course, you adjust for changing circumstances as they occur.

[Mar 20, 2013] Gold Daily and Silver Weekly Charts - New Zealand Goes Cyprus-Style, RBNZ Responds

Jesse's Café Américain
"Here in New Zealand the Reserve Bank is moving to add an Open Bank Resolution Policy (OBR) to tools it could potentially use in the event of a bank failure.

The implementation of OBR would see all unsecured liabilities that rank equally among themselves, including deposits, having a portion frozen. The Reserve Bank says the OBR policy could save taxpayers' more than NZ$1 billion regardless of whether there is a bank failure or not.

However, Norman points out that if a bank fails under OBR, all depositors will have their savings reduced overnight to help fund the bank's bail out."

Green Party Hits Out at NZ Government's Cyprus-Style Solution to Bank Failures

And the Reserve Bank of New Zealand responds:
"If their bank fails, depositors have always needed to understand that deposits are not guaranteed. What OBR does is facilitate a rapid and orderly resolution of a bank failure – it does not change the fact that depositors and other creditor funds are at risk...

The New Zealand Government has looked hard at deposit insurance schemes and concluded that they blunt the incentives for investors and banks to properly manage risks, and may even increase the chance of bank failure."

Reserve Bank of New Zealand, Open Bank Resolution, 20 March 2013

One understands that in the event of a bank failure, pain will be apportioned to the shareholders and depositors in New Zealand banks. And it must certainly be an extraordinarily transparent financial system indeed so that depositors can properly assess risk, on a par with insiders.

But one might ask, in the event of a failure, what is the penalty for the politicians, the banking management, and their regulators?

Oh that's right, there are no banking failures permitted in New Zealand. So perhaps it is a moot question. But it does seem that the people of New Zealand have some concerns and questions about this and, dare it be said, an imperfect confidence in their central bank?

Confidence, gentlemen, is the key. Oui?

And so we pray for the best, but prepare for the worst.

"Those entrapped by the herd instinct are drowned in the deluges of history. But there are always the few who observe, reason, and take precautions, and thus escape the flood. For these few gold has been the asset of last resort."

Antony C. Sutton

[Aug 19, 2012] In A Paper System, All Assets Are Backed by the Treasury Bond

08/17/2012

In a gold-based monetary system, every asset is ultimately backed by gold. This does not mean that every debtor (including banks) keeps the full amount of its liability in gold coin just lying around. Why would one bother to borrow if one did not need the money? It means that every asset generates a gold income and every asset could be liquidated for gold, if necessary. If a debtor declares bankruptcy, the creditor may take losses. But he can rely on the gold income stream for each asset or if need be he can sell the asset for gold. In a gold-based monetary system, money is gold and gold is money. Money cannot disappear; it does not go "poof".

Bad credit can be defaulted and must be written off. But money merely changes hands

Guest Post: Overruled

Cross posted from MacroBusiness

Ok, we all know that anyone who says "this time it is different" is to be treated at best as misinformed, at worst as a fool. "They are the five most dangerous words in the English language" etc. etc. But, to repeat my question: "Are things always the same?" Mostly, yes. Modern housing bubbles are not unlike 17th century Holland's Tulipmania, government debt crises have not changed all that much since Henry VIII reduced the gold in coinage, greed, profligacy, irresponsible plutocracies are always with us.

But in global finance there are some things happening that are genuinely different. Dangerously so. It is becoming a hall of mirrors, money referring to itself in an infinite regress. Little wonder that people are attracted to gold, because gold seems to be a tangible, solid measure of value, something we can rest on in an environment where everything seems relative. Yet this, too, is an illusion. The yellow metal only has value because it has a history of being deemed to have value. It is no more an objective measure of value than the pieces of coloured plastic, notes, that make up legal tender.

To explain what I mean, let's start with a definition of what money is. It is rules. Rules about value and obligation. Those rules are usually based on legally enforced structures, although that need not be the case. In the case of cross border capital markets, the enforcement is informal because there is no supranational government to impose penalties. Disputes are resolved by a handful of law firms, the main penalty is to be prevented from participating for a period.

Now if money is rules, then what does it mean to "de-regulate financial markets" as was claimed in the 1990s? Can you de-regulate rules? Obviously not. So what happened? The place where rules were set shifted.

Instead of government for the most part making the rules, the traders started making the rules. The logic was, as Alan Greenspan argued, that because everyone was acting in their self interest then nothing could possibly go wrong. Pricing would be accurate, the less formal self organisation of the market would be superior to the formal oversight of governments (what would governments, which are always bad, know?) and everyone would win. Free lunches as far as the eye can see.

So the rules proliferated, especially after the advent of the Black and Scholes pricing of risk, a clever piece of maths based on what is probably circular argument, but one that is sufficiently concealed to give traders the impression that they are handing off risk accurately. This led to the explosion of derivatives and securities markets, including such instruments as collateralised debt obligations, credit default swaps and endless hedging games (my personl favourite is a derivative on "volatility").

Now the point about rules is that they are based on agreement, and their creation can be without any limit provided traders are prepared to agree, to trust each other enough to transact. They are not finite in the way that, say, gold is. And so the rule making exploded. The global stock of derivatives is $US600 trillion, about twice the capital stock of the world (all the shares, property, equities, bonds and bank deposits). Far from deregulation making the rules of finance more more streamlined and more efficient - as if the efficiency of money could be measured anyway, given that it would mean measuring money with itself - the rule making expanded wildly. And we all know what happened when the trust that underlies those rules collapsed. The Global Financial Crisis. We are lucky to have a financial system left.

This era of meta-money, I submit, is different. It is "different this time". Some versions of it have appeared on the margin before. Hedging has a long history, for instance. But meta-money has never been the centre of the action before. In the past it has always been, for want of a better phrase, "normal" money: bank debt, equities, bonds, property and so on.

The massive volume of meta money, the ever expanding hall of mirrors, now dominates and distorts more conventional forms of money. For instance, the $3.8 trillion that is transacted every day in the US dollar makes the annual budget deficit of over $1 trillion look like chump change. About 8 hours trading. There will not be a crisis in demand for US debt, causing an economic collapse, while there is such intense demand for US dollars in the foreign exchange markets.

What is happening instead is that the logics of "normal" money are being used by the meta traders as a game (a game mainly of signs, semiotics) to try to make profits out of their exploitation of the rules of meta money. If the US government looks like it will reduce its government debt, then traders can make a play in the foreign exchange markets that the US dollar will rise. So the US dollar rises. Not because an imbalance is being corrected, changing the dynamics of supply and demand, but because a signal has been sent that an imbalance has been corrected, giving the traders something they can exploit. The rules of normal money are being overridden by the rules of meta money.

That is the world we are now in. It is why such huge distortions are appearing in areas like quantitative easing, extremely low interest rates, an ailing cost of capital, the hankering after something solid in precious metals like gold and silver, equity markets whose pricing seems strange. Governments have given up oversight of the financial markets, handing it over to the traders. We must now suffer the consequences as the traders try to outdo each other in an infinite game of pass the parcel. Or, more accurately, taking out bets on who will pass the parcel to whom.

Eventually, I suspect, GFC version 2 will come along, and the rules will finally collapse. Governments will have to come in and re-set them. There will be a huge re-regulation backlash. But how is it that governments allowed it to get to this stage? What ever happened to governing?

ambrit :

Friends; "How is it that governments allowed it to get to this stage?" May I suggest that, as your post points out, an inversion of values has occured. Money used to be a symbol, a proxy if you will, for power in the society. Now the symbol is mistaken for the object it previously represented. To be blunt, greed has overtaken the critical falcuties of the "elites." It is the same old story, as people like Galbraith and Bacevitch have so amply demonstrated. I'm beginning to understand a bit how the Stoics felt.

Bill:

Yves is quite a ways ahead of other economic thinkers in her critique of Wall St. banksters and their success in destroying this country, but whoever wrote this is dead wrong about gold. The precise reason why gold is valuable and will continue to increase in value as all paper converges into a singularity is BECAUSE it has had worth for millenia. Admittedly, its worth has waxed during times of economic uncertainty (Fall of Rome, French Revolution, Weimar hyperinflation, 1970's stagflation, etc.) and waned during times of economic certainty (1980-2000 most recently). But given our current trajectory, which scenario do you think is the most likely in the coming decade?

I feel that the reason that so many people have trouble accepting gold's imminent eminence over all things paper is because they were born into a world overflowing with technological, financial, fiscal upside potential. Like the fat tails which were found to be present in centuries of cotton price data, proving that markets do have memory and that the efficient market hypothesis is a load of BS, these financial and economic types are afflicted by thinking which has been addled by decades of Greenspan puts, $20/bbl oil, and Moore's law. Their synapses are fundamentally incapable of processing a world of scarcity and stagflation/default, where the oft-ridiculed Malthusian catastrophe hangs over us like the sword of damocles. I hate to sound like someone at the top of a bubble, but this truly is a new paradigm. Is anyone developing a new iphone app to squeeze more oil out of the depleting Ghawar field? If we close our eyes and click our heels together, can we make all oil abiotic in nature and ensure a limitless supply in perpetuity. There are thermodynamic limits on technology which, let me assure you, form a very hard wall. We as a society throw ourselves against it at our own risk.

ScottW:

One thing I can never get my mind around when it comes to gold is that the value is always expressed in terms of dollars–the currency that will become worthless over time. So, if you own lots of gold that is tied to worthless dollars what do you really have? Is the supposed end game that some day dollars will become worthless and gold will take over as an independent currency? And if that occurs, how do you value the current worth of gold? Seems to me gold is just another commodity that makes a few people rich in dollars on the trade. But what do I know, the only gold I own is in my teeth.

Susan Truxes:

It seems to me that it is precisely a scarcity of resources that now makes gold untenable as a store of value. Government will step up and take some action before it will pay 5k for a barrel of oil. For millenia gold has been accepted as the most valuable medium of exchange. Sometimes irrationally so. But never more irrationally than today. There isn't enough gold to help us let alone save us. This is a new paradigm. Time was when time was money. Before we ran out of resources. Is this the underlying cause for meta money? We've run out of things to buy and sell at a rational pace so we are buying and selling time, better known as derivatives, and trying to profit by split seconds. Can critical mass be far behind?

ambrit :

Gee Whizz Folks; If I didn't know better I'd think that I've fallen into a meeting of the "Renaissance Faire Organizing Committee!" As the late lamented Dick Nixon so amply demonstrated, a government can coopt any medium of exchange with ease in this modern world. Yes, Gold does have value; some industrial processes and a huge amount of symbolic heft. Consider though, most ordinary people don't have the resources to own gold, or the sequestration of productivity that entails. For the 'rest of us' the precious metal within reach is Silver. And look how far over the place it's been lately. Alas, I'm afraid that Gold, with all its lustre, will remain a tool and symbol of the elites. And, notice, due to its scarcity, one of its primary functions in the bad old 'good old days' was to limit and channel economic activity. The precise beauty of fiat money is its 'magical' ability to expand the horizons of economic activity, with an attendant rise in the general standards of living. Gold has its place, after we've been fed, housed and clothed.

g kaiser :

I find the thinking in this piece refreshing, to a point, but the writer has not drawn the conclusion, as the logic bites itself in the tail. Everything in here is the essence of why gold is the only place of refuge. Gold is not somebody's liability, it is value without someone having to make good on a promise. It is a parcel that does not have to be passed on, it cannot be created at will, multiplicated ad infinitum. What might be left after this financial crisis has run its course will be barter and gold. Many fiat currency will cease to exist. Gold won't. Any idiot can see that deranged individuals paying themselves untold fortunes at the expense of countless poor is not a tenable long term strategy.

John Emerson:

The only time gold is more valuable than fiat currency is when you have complete political collapse. In that case, our gold has value but you have to have it in your physical possession (not in a vault someone else controls), and you have to be able to protect it from bandits and tax collectors.

A lot of gold still remains buried in the ground for safety by someone who didn't live to come back and dig it up again.

Gold and silver are speculation commodities, and around 1980 goldbugs who believed the myth lost billions of dollars.

We're all pretty much at the mercy of the national and world economy. The gold standard might give people an illusion of security, but it doesn't protect against economic decline, and gold hoarding slows economic growth.

bookit:

Food and shelter are what's valuable in a complete political collapse.

nonclassical:

Circa 1974, one of Bruce Lee's student-instructors asked his students, "Where would you get food without Safeway?"..

It doesn't take much leap of imagination to comprehend what such a rapid transformation as valueless "money" would bring this society..

IdahoSpud:

Agreed. In an anarchic society, what do you think has greater value: a roll of Krugerrands, or a grass-fed feeder cow?

Yves Smith:

The faulty logic is that gold does not work at all well in economic collapse. Nothing does. Women in Vietnam used gold much as Indian women do, as a store of wealth, often in necklaces of gold beads. When Vietnam was war-torn, they'd trade their gold for far far less that it "ought" to have been worth to obtain food and medicine. The idea that gold will have some sort of stable, reliable value when an economy is reduced to barter is nuts.

The best protection against that outcome is to be a doctor, the general practitioner type. Seriously.

George H. W. Bosch:

And as an additional bonus, the 1/4 million in student loans you take out won't be owed after the collapse.

g kaiser:

No doubt about that. However, how did they do with the folding type of money? Lit their fires, stuffed their mattresses? because it had NO value, having seized to have any way before. Most likely some food coupon or a tin of sardines could be more valuable.! If a drought, water is most valuable, in a famine food is, in a case of governmental international fraud, gold is.

Let's compare apples with apples.

Lurker:

"There will be a huge re-regulation backlash."

Only in your dreams kemosabe. The current rules are there to cause the transition from republic to empire, from capitalism to feudalism, from freedom to slavery, and to funnel all accumulated wealth into the hands of the financiers.

nonclassical :

only if the money grubbers can keep the whole thing from crashing-history shows us they can't..perhaps especially in nano-second computerized transactions…

frances snoot :

"That is the world we are now in. It is why such huge distortions are appearing in areas like quantitative easing, extremely low interest rates, an ailing cost of capital, the hankering after something solid in precious metals like gold and silver, equity markets whose pricing seems strange. Governments have given up oversight of the financial markets, handing it over to the traders. We must now suffer the consequences as the traders try to outdo each other in an infinite game of pass the parcel. Or, more accurately, taking out bets on who will pass the parcel to whom."

What is taking so long is the G20 expansion of sdr. A different world in October when banks deleverage?

http://www.bloomberg.com/news/2011-04-16/draghi-sees-european-banks-raising-capital-within-a-year-1-.html

Blame it on the traders and ignore the agency of one. Obama should wear a habit.

[Jan 11, 2011] Resist Gold's Charms? by Tim

January 11, 2011

Every once in a while I begin to think that maybe, just maybe, the price of gold can't go any higher after ten straight years of gains during which it has more than quadrupled. But, then I read an article like this one in Money Magazine that, once again, makes clear that, in the West, the metal is still reviled by most writers in the mainstream financial media and it is loathed by most investment professionals (even more so as the price goes higher each year).

Gold is a bubble – resist its charms

Can you tell when a boom has turned into a bubble? One clue: When pop culture starts paying attention. The housing bubble, for example, brought both the TV show Flip This House and a rival on another network, Flip That House.

So if you own a lot of gold, you might regard a recent episode of Saturday Night Live as your first warning. In the opening skit, Bill Hader as China's President Hu Jintao declares that Glenn Beck was right and that "my government should have bought gold. Unfortunately, all our assets were tied up in U.S. Treasury bills."

Back in the real world, gold is trading at about $1,400 an ounce, up from less than $500 five years ago. That's a 23% annualized return, far outstripping the gains on stocks (1.1%) or bonds (6.1%). Fear is driving a lot of the rise.

You may be wondering whether you should be getting a piece of this action. This time last year, MONEY argued that although gold prices could continue to climb in the short run, the case for gold as an investment no longer made sense.

And that leads to another truth about bubbles: You'll almost never look smart trying to call them, at least at the outset. The real estate bubble was six years in the making; the dotcom bubble lasted five years before bursting.

The gold bubble could stay pumped up for a while. But that doesn't make gold less speculative and risky than it was a year ago.

They go on to cite three reasons why you should be fearful of any investment in gold – none of which were very convincing to me. The entire piece is worth reading as it provides the clearest indication in weeks that the gold bull market still has a long way to go.