Over at VoiceofSanDiego.org I’ve put up a two-parter explaining why I believe a protracted period of deflation is an exceedingly unlikely outcome.
No Deflationary Spiral Forthcoming, Part 1
No Deflationary Spiral Forthcoming, Part 2: Counterpoints
(These articles comprise a very slight retooling of the "US Government Won’t Choose Deflation" piece linked to at the upper right of this page — so if you’ve already read the original one, there’s no need to slog through these too).
Excellent articles! I never
Excellent articles! I never connected the deflation(economic) angle to the savers(political)agenda. My only comment is that trillions of dollars are on the sidelines right now and I think the threat of inflation will make them play again.
Great article, Rich…I’ve
Great article, Rich…I’ve been having many of the same thoughts you have for some time, and you characterized them well. The one thing I think will be very interesting: monetary policy is a very blunt instrument with long lag times, and inflation indicators are often very much lagging.
I envision a world where deflation is the operative word through 1H09. This leads to a large policy response as you suggest. This stokes inflation, and eventually, you wind up with a Volcker like figure at the Fed to bring it back under control.
I keep thinking back to Bernanke’s confirmation hearing. Fears that he was an inflation dove were paramount, and it’s now clear that those were well-founded.
I also think deep down that Bernanke believes inflation is the answer. If you are an economist thinking positively (in the economic sense of the word), inflation might even be the preferred option to deflate the bubbles that still exist. On the normative side, you have to be willing to stick it to the savers and the prudent, but that seems to be something our leaders are more than willing to do.
I’m saddened by the state of this all, but fascinated to see how it plays out.
One last thought that I find interesting: In the end, saving is essentially an act to buy a right to consume future production. The world is aging, so the demand for assets that buy a right to this future production may exceed the ability of the world to produce them efficiently (either due to labor shortages, or resource limitations). The end result has to be a reduction of returns on assets (I’d argue we are seeing this earlier than I, at least, thought we would), or higher returns on labor.
I get the sense that the workforce will reap the benefits of the desperate need to consume the baby boomers will have. This will support wages, but place continued pressure on asset returns.
My thoughts on this aren’t completely formed, so I’d love to hear what others think.
Thanks again,
Stan
It’s a great article with
It’s a great article with lots of things addressed, I learned a lot.
I have a few questions for clarification please if anyone would like to provide input. In the example for Alice, quote:
“In other words, no money has been destroyed — it’s just been moved around. There has been no change in society’s aggregate ability to spend”.
I believe no money has been destroyed but I am not sure yet about the strong linkage to “There has been no change in society’s aggregate ability to spend”.
1. I believe that “society’s aggregate ability to spend” relate to more factors than just the money supply. One of them would be credits. For example, the guy who bought the stock from Alice didn’t really have 3 millions. He borrowed part of it from some banking investors (before the crash he could borrow 3 millions, after the crash he could only borrow 2 millions). So he didn’t really have 1 million extra and he couldn’t borrow that 1 million extra.
The author did address in the paragraph about credit deflation that yes, in practice the banks could create lots of credits and magnify the effects of the money supply. However, my belief is that the capability to do it does not mean they will once again throw money and credits away to risky projects, assets in declining economy in a state of deflation. And as long as they do not find economically sound basis to invest, they would rather deleverage and ensure safety, decreasing others’ ability to buy, borrow, invest..etc.
2. Second factor I was wondering about is the international investors in American assets. The reason for my question is that when we use the phrase “society’s aggregate ability to spend”, I keep thinking it’s only our country here. But the price, money supply, credits supply, etc are significantly determine by world investors into America. So when they pull back because of a significant trust problem, even if our aggregate ability to spend could stay the same, it would still be a significant deflationary force IMHO.
Final point, I think that deflation will not only come from our “aggregate ability to spend” but also from our “aggregate will to spend”. For sure the govt is going to spend like crazy but I don’t think any of my friends will be spending like crazy like the government regardless of my friend’s “ability to spend”. In a deflationary environment, my friends would save the money so that he could buy a bigger TV in the next couple month. Now, that’s his belief, his will, actions, his logic, so it may have nothing to do with how successful the government will be able to engineer inflation.
My 2 cents just to add discussions for fun. Hats off to the author.
Thanks everyone for the nice
Thanks everyone for the nice comments.
A couple thoughts on KIBU’s post.
[quote=KIBU]
I have a few questions for clarification please if anyone would like to provide input. In the example for Alice, quote:
“In other words, no money has been destroyed — it’s just been moved around. There has been no change in society’s aggregate ability to spend”.
I believe no money has been destroyed but I am not sure yet about the strong linkage to “There has been no change in society’s aggregate ability to spend”.
1. I believe that “society’s aggregate ability to spend” relate to more factors than just the money supply. One of them would be credits. For example, the guy who bought the stock from Alice didn’t really have 3 millions. He borrowed part of it from some banking investors (before the crash he could borrow 3 millions, after the crash he could only borrow 2 millions). So he didn’t really have 1 million extra and he couldn’t borrow that 1 million extra.
The author did address in the paragraph about credit deflation that yes, in practice the banks could create lots of credits and magnify the effects of the money supply. However, my belief is that the capability to do it does not mean they will once again throw money and credits away to risky projects, assets in declining economy in a state of deflation. And as long as they do not find economically sound basis to invest, they would rather deleverage and ensure safety, decreasing others’ ability to buy, borrow, invest..etc.
[/quote]
I think you are conflating credit and money here. Outside the fractional reserve banking system, a credit transaction does not create any ability to spend — it just transfers spending power from the lender to the borrower. Inside the fractional reserve banking system, a credit transaction CAN create the ability to spend — but it does so by creating more money.
I believe you are saying that risk aversion will cause the banks to be less likely to lend, thus creating less money. And I agree with that. And money supply growth did flatline earlier in the year. But if you look at the monetary aggregates you can see that money supply is already rising quite rapidly, probably as a result of all the reflationary efforts.
[quote=KIBU]
2. Second factor I was wondering about is the international investors in American assets. The reason for my question is that when we use the phrase “society’s aggregate ability to spend”, I keep thinking it’s only our country here. But the price, money supply, credits supply, etc are significantly determine by world investors into America. So when they pull back because of a significant trust problem, even if our aggregate ability to spend could stay the same, it would still be a significant deflationary force IMHO.
Final point, I think that deflation will not only come from our “aggregate ability to spend” but also from our “aggregate will to spend”. For sure the govt is going to spend like crazy but I don’t think any of my friends will be spending like crazy like the government regardless of my friend’s “ability to spend”. In a deflationary environment, my friends would save the money so that he could buy a bigger TV in the next couple month. Now, that’s his belief, his will, actions, his logic, so it may have nothing to do with how successful the government will be able to engineer inflation.
[/quote]
Here, you are basically talking about willingness to spend, not ability (in the parlance I was using — but don’t get too hung up on my turns of the phrase, I just kind of made them up).
The point I am trying to get across is that there are two things: ability to spend, and the will to spend. A major point of my article is to separate these two factors out to gain a better understanding of what’s at work.
The point is NOT to say that willingness to spend has not declined — because I fully agree that it’s taken a mighty swan dive. But many people are confusing this with the overall disappearance of money (which hasn’t happened), and that’s what I’m trying to get across.
BTW the great Jeremy Grantham just came out with his quarterly letter and he describes the issue in an interesting way:
Whole thing here: https://www.gmo.com/America/CMSAttachmentDownload.aspx?target=JUBRxi51IIBfJXb8ASd8%2bfe6xTnek30r%2fSsfGLZdf%2fgBjNfDjVKz9zThOLvkRsKheOtJDKEGJYxIjobQX%2bjp88EZ5lV%2fmtWGUUktMMu9ps8%3d
(You might need to register but it’s well worth it).
Rich
What do people think the
What do people think the deflation/inflation cycles predicted here will do to housing prices?
Maybe drop short term since there are too many downward factors contributing to a price decline? Then things stabilize in 2010-2011? Without inflation, I gathered (from reading stuff here) that we were in for a long slow price decline over the next five years or so.
I have the same question as
I have the same question as Ralph.
Doesn’t the rebound of the housing market ultimately depend specifically on wage inflation? Shouldn’t this be the marker most directly correlated with a housing value turn around?
Since you described, Rich, a scenario where it’s quite possible to have high inflation in the midst of a recession (with presumably high unemployment), my question, put another way is: will inflation only translate into higher housing values if it is accompanied by low unemployment and higher wages?
Fletch wrote:I have the same
[quote=Fletch]I have the same question as Ralph.
Doesn’t the rebound of the housing market ultimately depend specifically on wage inflation? Shouldn’t this be the marker most directly correlated with a housing value turn around?
Since you described, Rich, a scenario where it’s quite possible to have high inflation in the midst of a recession (with presumably high unemployment), my question, put another way is: will inflation only translate into higher housing values if it is accompanied by low unemployment and higher wages?[/quote]
Good and, of course, relevant question.
I think that one of the big misconceptions that the mainstream has about inflation is that it is like someone spreading peanut butter over a piece of bread — that it increases all prices more or less equally. This may be true over VERY long timeframes, but in the shorter term, inflation tends to seek out that which has the most limited supply or the highest demand.
As of now, housing is oversupplied, so it is unlikely to be a big beneficiary of inflation. But if the oversupply gets worked through at some point, that could change.
Generally I think you are right that wages are the most important fundamental for housing prices. If inflation does push wages up, that will help home prices, as wages are a huge source of “nominal” demand. In addition we will have “real” demand factors (population, housing supply, popularity of real estate buying) affecting homes prices.
One other factor is mortgage rates… if inflation drives rates up, that could reduce nominal demand by reducing the amount people can spend cashflow wise. But if Bennie keeps mortgage rates artificially low, this isn’t a factor.
There is no clear answer to this one, as my ramblings indicate… I am just throwing out some thoughts.
rich
“The Window”
As this economic
“The Window”
As this economic downturn continues, I think it is worth a comment about the recent, unexpected by most, dramatic drop in oil prices to as low as about $32/barrel, with other commodities also dropping significantly.
Plus, with the dramatic drop in RE prices and stock prices, much money, and debt, has been removed from circulation or debt burden or possible circulation or debt burden, in the near term. So, as the government is essentially printing money by the trllions of dollars in trying to stabilize the financial system, stimulate the economy, etc, we have been granted a “window” to allow the “printing of money and issuing debt” as long as it is wisely used – like for investment in our infrastructure, energy, education, healthcare, etc – things which will eventually return more than they cost plus create jobs as unemployment has been increasing significantly.
The stock market has already had about $7T vanish, and RE probably more if commercial RE is included. So, for now, the expansion of money and debt to the amount of even a few trillion dollars, I just don’t see as inflationary or of imminent danger to our currency. Yes, we must also come up with a plan to begin paying down our budget deficits and the large national debt, but for now, we have a “window”.
The stock market has already
The stock market has already had about $7T vanish, and RE probably more if commercial RE is included
$7 trillion has not vanished… this is discussed at length in the second article.
Rich
To the Window post:
First
To the Window post:
First off, the stock market hasnt lost that much money. The value of stocks on the stock market may have fallen by $7T, but the money didnt go anywhere in particular. I have some stocks I bought years and years and years ago. They were worth alot more a year and a half ago, but I still own them. I havent gained or lost anything other than a sense of happyness when looking at the total value of my portfolio. The money is still out there, people just wont give me as much of it as they use to.
Second off, your window assumption says politically correct things like “infrustructure will return more than it costs”. Says who? There are tons of boon-doggles that the government could pour money into that will never turn a great amount to society. Load these projects up with overpaid (union?) labor, tons of enviromental watch dogs, indicisive goals (your real goal is to create jobs right? Why finish the project and fail?) and general government ineptnes and alot of these projects could suck for a decade or more.
Or we could spend tons of money on schools, that is always politically popular. ‘Invest in the next generation’ (mostly by robbing them blind BTW). But that doesnt mean that the kids will be smarter, or that they will go farther in life. Ca has been pouring money into the school system for a long time, and our schools are no better or alittle worse. All the fancy Computer labs and sports facilities wont make kids learn a damn thing if they dont want to. What is the point of learning math if the only jobs are digging ditches for the Federal governmnet or filling them in for the state government?
Look, the point isnt that all projects are crap, cause some are needed. But saying that all the projects will return more to society than they cost is a no win statement. If it wasnt viable to build it before, why is it viable to build it now?
The US govt may want
The US govt may want inflation, but I doubt they’ll get it. The debt/credit markets wont let them. The employment markets wont let them. All they could do would be to monotize the debt and that’s a currency collapse, not inflation. To argue that we have not seen price declines in vitually every asset class is crazy. We have seen huge declines. And credit, which is a form of money, has been decimated. These are all deflationary signs. The stock markets loss was calculated at $30T when I last read it. Add a few more trillion to real estate and you’ve got deflation of wealth as well as money. I dont see how this gets better with the govt spending $3T!?
Credit is constricting and value has been decimated. The wealth effect has been severly impaired. Remember, money saved or invested is a future call on it’s use. That has been greatly devalued. Just ask someone with a 401K that’s in their late 50’s or early 60’s. Or perhaps someone who’s become unemployed. A paper loss is real in that it is opportunity or value lost that could have been utilized.
We’re not in a deflationary spiral? Tell me what all the newly built cars are doing in the USA right now? How about home prices? Consumers are saving for the first time in many years. They’re not spending for two reasons. 1)Unemployment is climing fast. 2) Prices are declining on most items. Deflation wont last forever, but it’s got a ways to go. Production will be cut way back, more people will be laid-off and eventually we will hit an equillibrium level. But we’re not there yet. This is global.
The US govt may want
How is a currency collapse not hugely inflationary?
Nobody is arguing this, just to be clear. The closest I came was to point out the energy notwithstanding, the prices of goods and services really aren’t declining all that much.
Comparing the amount of govt money creation with the amount of asset price declines is comparing apples to oranges. And the "opportunity" lost by the holders of now-devalued paper assets is offset by corresponding gains for everyone else. This was all addressed in the second article.
You are citing a lot of reasons why real demand is declining and may continue to decline, but the point of my article isn’t to argue against that — it’s to argue that this will be offset by a decline in the purchasing power of the currency.
Thanks for the comments.
Rich
KIBU, your final point is
KIBU, your final point is well-taken and it is the cornerstone of my own feelings on where we are and where we are headed. I believe it starts and ends with consumer behavior, including in great part consumer psychology. On that presumption, it really is neither here nor there whether wealth has in fact “evaporated” or merely been transferred. Trying to explain these concepts to the man on the street who has watched his 401K balance and home equity whither is not going to get you very far. The man feels much worse off, much less wealthy, and is almost guaranteed to be far more cautious with expenditures and taking on new debt going forward.
First and foremost, I see no significant and sustainable general inflation without corresponding wage inflation. It simply will not go without higher wages. I will take it one step further and add that job security/economic optimism is also a necessary component of such inflation. We’re talking generalities as to inflation, of course, as we could go on all day breaking down inflation of particular goods/services.
I do think access to money plays a secondary role in supporting inflation, but due to the debt mountains now being faced and what has developed into a general aversion to more debt, I see access and availability playing a much more minor supporting role than if we were coming out of different debt-load history.
Simply stated I do not believe consumers can or will support higher pricing without wage inflation. And even with wage inflation, I think there will be a longer than expected lag until they will support higher pricing due to debt hangovers and concerns about economic stability. So I’m not seeing significant or sustainable inflation anytime soon as I’m not seeing wage inflation anytime soon, particularly in conjunction with strong feelings of job security. Just my thoughts.
Trying to explain these
Trying to explain these concepts to the man on the street who has watched his 401K balance and home equity whither is not going to get you very far. The man feels much worse off, much less wealthy, and is almost guaranteed to be far more cautious with expenditures and taking on new debt going forward.
Once again, I never argued against that and as a matter of fact I made that same point in the article. The point of that section was to counter the oft-repeated argument that $10 trillion (or whatever) of asset price declines is equivalent to $10 trillion of money disappearing. It just isn’t. Yes, people feel less wealthy, but no money has disappeared, as so many people are wont to argue.
I feel this is a key distinction because people are comparing the money supply growth to the amount of asset price declines, and these just aren’t two things that bear comparing.
I am pretty much in agreement with your point on wage growth. I also think that there is downward pressure on REAL wages. Nominal wages is a different story.
As I mentioned in my response to Peter, people are really focusing on the determinants of REAL demand. This is important, but I think it’s dangerous to treat dollars as a sound and consistent measuring stick. The Feds will see to it that the dollar loses purchasing power — and if this is happening, nominal prices/wages/etc can rise even as real demand is declining.
Rich
Yep, money has vanished,
Yep, money has vanished, multi-trillions of it.
If someone’s stock holding was $10,000, for example, he/she could have sold it and collected that amount of money. So, the way our financial system works, is that is how many dollars in currency was backing the stock, whether or not it was actually called upon to be delivered. Believe it or not, our outstanding money supply is not just stacks of paper bills with pictures of George Washington, Lincoln, etc on them.
Same with RE, commodities, etc. Plus, the same with debt. If a home is foreclosed, the mortgage is eliminated. The debt disappears. Plus, the bank or financial institution counts mortgages held as assets. If a mortgage is wiped out, the firm has less assets, hence less money.
So, yes, there is indeed a “window”. Sure, the key is to establish a plan to begin reducing the deficit and national debt before that window closes. And, sure, more of that new money created should be used to invest in things which will return more than they cost. But, even if maybe half or so doesn’t that is still OK, at least for now. Better to err on not spending enough right now, than not enough, while there is that “window”. We need more money in circulation right now, currently too much is frozen. The only caveat, is that the spending plan should be structured so to minimize the amount of money leaving the country.
http://josephoppenheiminvesting.blogspot.com/
Joseph Oppenheim wrote:Yep,
[quote=Joseph Oppenheim]Yep, money has vanished, multi-trillions of it.
If someone’s stock holding was $10,000, for example, he/she could have sold it and collected that amount of money.
[/quote]
But wouldn’t that $10,000 have come out of someone else’s pocket. Net change in total dollars is Zero.
Suppose your example then sold his stock when it dropped to $5000. Sure he came up $5000 less than he would have if he sold at $10K, BUT the buyer saves $5000 in this case by buying at a lower price. Net change in total dollars is zero.
[quote=Joseph Oppenheim]
If a home is foreclosed, the mortgage is eliminated. The debt disappears. Plus, the bank or financial institution counts mortgages held as assets. If a mortgage is wiped out, the firm has less assets, hence less money.
[/quote]
But,isn’t the debt from the former homeowner relieved, resulting in a net increase in his net worth. Again a zero sum game in terms of dollars in the system.
But wouldn’t that $10,000
But wouldn’t that $10,000 have come out of someone else’s pocket. Net change in total dollars is Zero.
Suppose your example then sold his stock when it dropped to $5000. Sure he came up $5000 less than he would have if he sold at $10K, BUT the buyer saves $5000 in this case by buying at a lower price. Net change in total dollars is zero….
But,isn’t the debt from the former homeowner relieved, resulting in a net increase in his net worth. Again a zero sum game in terms of dollars in the system.<<<<<< No. 1) the buyer needs less money to buy the stock. 2) the homeowner is net negative (equity lost - if was negative equity then the actual amount of money had already vanished) and the bank is out of an asset (the mortgage - if mortgage more than value of home - if home worth less than mortgage, that asset, the mortgage, had already evaporated some value - ie. money). During this deleveraging and devaluation of assets, new money is worth more - it can buy assets cheaper and labor cheaper, at least during this "window".
Lots of good comments, I’m
Lots of good comments, I’m going to answer some below. But first, a fellow writer at Voice wrote a pretty lengthy counterpoint, which i counter-countered here in case anyone is interested:
http://voiceofsandiego.org/articles/2009/01/23/toscano/742deflationweek012308.txt
More comments below.
rich
Yes, prices can inflate
Yes, prices can inflate during times of economic contraction.
So, why can’t prices deflate during times of monetary inflation ?
—
Lets say the Fed writes everyone a $1000 check, and everyone sent the check to the bank to buy down debt that was printed into existence.
Is this inflationary, deflationary or neutral ?
sdduuuude wrote:Yes, prices
[quote=sdduuuude]Yes, prices can inflate during times of economic contraction.
So, why can’t prices deflate during times of monetary inflation ?
—
Lets say the Fed writes everyone a $1000 check, and everyone sent the check to the bank to buy down debt that was printed into existence.
Is this inflationary, deflationary or neutral ?[/quote]
OK, people are posting comments faster than I can reply!
Inflationary. First, it increases the money supply and while there are lags, money supply is the most important driver of long term inflation or lack thereof.
Second, you just freed up the money they would have spent to pay down that debt. Even if they were only paying that down $100/yr, you just freed up $100/yr for them. Or, if they were going to pay it down all at once a year later, you just caused inflation from where it would have been a year later, because now they have that money to spend.
It becomes clear why there are lags — but this is definitely inflationary (and btw, if the govt gives poeple stimulus checks and they pay down debt, the govt can always keep giving more til the debt is paid down!)
Rich
I have an answer to your
I have an answer to your “turn around” but first –
I agree that the Fed check -> citizens -> bank is inflationary, but isn’t it money-supply neutral if the printed debt is paid off and vaporized?
I’m assuming the bank does not keep the money, but returns it to the Fed.
Rich,
Here’s the banking
Rich,
Here’s the banking exposure to submerging growth economies. The US compared to the Eurozone banks as a percentage of GDP:
Eurozone 335% [Est. $41 trillion]
United States 65% [Est. $9.8 trillion]
(Props- I got this data from Jack Crooks currency newletter.)
This would suggest that although US banks were at the begining of this credit burst, they’re not in this thing alone nor in any worse position than Euro banks. Also, take a look at the success of Eclectica’s fund and Hendry’s comments on govt debt…treasuries will become very popular again if there’s another leg down in the markets this year. As well as other countries wanting to keep the US$ stronger against their own currencies. This is part of the logic behind the US$ gaining in strength, not falling. But I also think it will help gold as well. The fiats are going to ZIRP. How far can the Euro be from there now?
Sorry for the rebuttal, but I think there’s a lot of energy behind a stronger US$ rather than a weaker one in the coming year.
The 1970′ had union wages at an all time high and the oil embargo bringing us to our knees. So there was wages and major costs rising. I dont see that as a money supply causation. That’s supply/demand manipulation. Which is really what prices are all about. Money supply is not a given for price inflation. It creates an environment that can lead to price inflation, but it’s not an absolute cause and effect relationship. If all the money goes somewhere and sits there, then there’s no velocity and no effect on prices. And I guess it’s prices that we all care about in the end.
Re. the 1970s: check out this
Re. the 1970s: check out this chart of M2 growth during the decade.
That was some serious money supply growth. The stuff about unions, oil shocks, etc was at least partly a smokescreen imho so that the politicians could goose the money supply and blame the inflation on something else. After all, if money supply is fixed, and the price of one thing (eg oil, or wages) goes up, the price of/demand for other stuff has to go down to compensate. A PROTRACTED rise in the general price level can only take place in an environment of excessive money supply growth (and here I include previous money supply growth, a la the Weimar Germany example i gave in my third Voice article, since there can be lag times in the years).
Here is a chart showing the ebbs and tides of CPI and money supply growth over the decades… there’s a lot of noise over shorter timeframes, but using 10 year smoothing there is clearly a relationship.
BTW no need to apologize for rebuttals, these are all great comments.
Rich
Here is a chart showing the
Here is a chart showing the ebbs and tides of CPI and money supply growth over the decades… there’s a lot of noise over shorter timeframes, but using 10 year smoothing there is clearly a relationship.<<<<<< Yep, thanks for proving my argument. Money supply has effectively been declining with the housing bust, stock bust, commodity bust, etc. And, recent CPI numbers reflect that. Can this contraction last forever? Certainly not, but, for now, we have this "window". In fact, if we don't use it, we will be in worse shape. The markets NEED more dollars. The only real option, is how to wisely decide how to spend them. Again, thanks for proving my point, though it really wasn't necessary. http://josephoppenheiminvesting.blogspot.com/
Here is a chart showing
Alright, dude, you have now entered the realm of the nonsensical.
To recap, you just looked at a graph that shows money supply increasing (one of the many graphs one can find that shows money supply increasing, I might add). And your takeaway is that this graph — the one with the little lines that show the money supply increasing — "proves your point" that money supply is actually DECREASING.
Nice work.
Just fyi, odds are I’m going to be ignoring the rest of your posts. It just isn’t a good use of time to go back and forth in this manner. If you need something to do, I recommend you spend some time looking at this graph of the US money supply.
Rich
Rich Toscano wrote:
Here is
[quote=Rich Toscano]
Alright, dude, you have now entered the realm of the nonsensical.
To recap, you just looked at a graph that shows money supply increasing (one of the many graphs one can find that shows money supply increasing, I might add). And your takeaway is that this graph — the one with the little lines that show the money supply increasing — "proves your point" that money supply is actually DECREASING.
Nice work.
Just fyi, odds are I’m going to be ignoring the rest of your posts. It just isn’t a good use of time to go back and forth in this manner. If you need something to do, I recommend you spend some time looking at this graph of the US money supply.
Rich
[/quote]
Rich, this is a case of someone who found a conclusion and now is looking for data to support it. Amazing what people can rationalize if they think it is “for the greater good”.
Rich Toscano wrote:
Here is
[quote=Rich Toscano]
Alright, dude, you have now entered the realm of the nonsensical.
To recap, you just looked at a graph that shows money supply increasing (one of the many graphs one can find that shows money supply increasing, I might add). And your takeaway is that this graph — the one with the little lines that show the money supply increasing — "proves your point" that money supply is actually DECREASING.
Nice work.
Just fyi, odds are I’m going to be ignoring the rest of your posts. It just isn’t a good use of time to go back and forth in this manner. If you need something to do, I recommend you spend some time looking at this graph of the US money supply.
Rich
[/quote]
Gee, I’m glad you saw through and responded to that comment first, otherwise I might have been rude to that guy and called him a bonehead … or something worse. He’s right that there is a window, but his appears to be a bit fogged.
I’ve seen a chart recently
I’ve seen a chart recently that showed total debt in the US, both private and public, at somewhere north of 225% of GDP from 2002 to 2007. On an 80 year graph, this 5 year period almost goes off the chart. To me, this explains almost every asset class going up in price for that period of time. RE, equities, commodities, PM’s, etc… That seems like inflation to me. How long does this gigantic credit bubble take to unwind? If you consider credit as part of the money supply, then we’ve lost a lot in the last year. I dont think we can have another run up of inflation until we’re through deleveraging. With foreclosures rising higher this year, unemployment rising above 9% and credit much harder to get, I still dont see where the velocity of money will get up to speed. The publics appetite for debt is dwindling and lenders desire to lend is going down with it. Wage pressure looks to be downward.
A high correlation does not always mean causation. The rooster crowing in the morning, etc…
The govt flooding the banks with liquidity does not seem to be getting them to lend or people to borrow. And corporate rates are very high right now. Perhaps the lag time will be when deleveraging has completed and the money can flow into other places?
The markets seem to still be in a fear mode. I dont think we’ll see inflation this year. The whole world looks to be contracting.
Well Rich I guess we are just
Well Rich I guess we are just going to have to agree to disagree re causation of the 70’s inflation. No worries as I have yet to be convinced by even the purest of monetarists on this issue…:)
Setting embargos, trade union impact and productivity/supply issues aside and looking strictly at the money supply: re the M2/CPI chart you recently posted – I am assuming by posting such that you are from the faction of monetarists that holds M2 as the best indicator. If true we disagree on this as well as I have always looked to M1 first and foremost, in light of the fact that as you know M2 includes savings and timed deposits, giving rise to the obvious misleading “double-counting” criticism.
I have yet to hear a convincing argument that M2 is soley a supply number as opposed to also including prior supply that has merely changed ownership. Point being that if M1 is the best indicator, it would be an M1/CPI graph in the 70’s that would be directly on point and provide the clearest graphical evidence of the relationship between what is truly an increase in the money supply and the relationship to the CPI. I’ll poke around later today and see what is out there, but based upon the M2 graph I suspect as I stated earlier that what we will see is CPI significantly outpacing M1 during that time period.
I actually think MZM is the
I actually think MZM is the most meaningful of the indicators offered by the Fed. I agree M2 has potential for double-counting but I think it is a decent enough indicator for the long term trends. M1 hasn’t been a good indicator for a long time.
All three monetary aggregates, incidentally, are rising very fast, so in a sense it doesn’t matter which you pick:
M1
M2
MZM
The topic of monetary aggregates is a whole other subject about which many worthy folks have written. My personal views are most in alignment with those of the Swedish economist Stefan Karlsson. He has written much good stuff about the various monetary aggregates at his blog (though you will have to search or poke around the archives to find them):
http://stefanmikarlsson.blogspot.com/
And with that I’m going to have to sign off from this thread, at least for a while, as I have already spent about as much time on it as I can afford.
Thanks everyone (well, most of you, anyway) for the great comments and discussion.
Rich
Thanks Rich.
I just reread
Thanks Rich.
I just reread your articles to give them more thought. My conslusion is that you’re probably correct. But the question is when? I’m thinking currency debasement while unemployment is still high and private lending is still slow. In other words, more nationalization of our economy. I think this is also a path other countries are on as well. So although the US$ could be relatively strong to other currencies, it will still be devalued.
I may be buying more gold here pretty soon.
Did I understand you correctly regarding credit as not being part of the money supply?
sdduuuude wrote:I have an
[quote=sdduuuude]I have an answer to your “turn around” but first –
I agree that the Fed check -> citizens -> bank is inflationary, but isn’t it money-supply neutral if the printed debt is paid off and vaporized?
I’m assuming the bank does not keep the money, but returns it to the Fed.[/quote]
That sounds right… if they pay back a bank, and the bank doesn’t re-lend it out, but instead just sites on it, it would be money supply neutral.
But, if the bank had not been planning on re-lending the money out, and the dude had to pay it back from his own wages or whatever, that would have been money-deflationary. So in your example, rather than creating money inflation they are preventing a money deflation. If that makes sense.
Rich
sdduuuude wrote:Yes, prices
[quote=sdduuuude]Yes, prices can inflate during times of economic contraction.
So, why can’t prices deflate during times of monetary inflation ?
—
Lets say the Fed writes everyone a $1000 check, and everyone sent the check to the bank to buy down debt that was printed into existence.
Is this inflationary, deflationary or neutral ?[/quote]
Sorry, didn’t answer the first bit.
Prices can decline in a monetary inflation, for a while (eg now!), but eventually monetary inflation catches up. Meanwhile, our govt reacts to the price declines the whole time and steps up the monetary inflation even more.
BTW can I kind of turn the question around? I wonder why everyone wasn’t panicking that, when stock prices were going up, it would cause huge inflation. Now stock prices are going down, and everyone thinks this will cause some huge deflation. Why the one way causality? What of the fact that the world’s greatest stock bull market took place during a period of secular declining infltion?
Rich
Woohoo, I’ve caught
Woohoo, I’ve caught up!
Better go feed the dogs before they savage me… they’ve been growling in protest at my feverish typing for the last half hour.
Rich
Darn. I’m heading out of town
Darn. I’m heading out of town for a few days. Wish I could join in. Well put, Itokuda.
Joseph Oppenheim wrote:Yep,
[quote=Joseph Oppenheim]Yep, money has vanished, multi-trillions of it.[/quote]
No, it hasn’t. I wrote at length to dispel this myth, and also included charts showing that the money supply has increased, not decreased.
If you want to argue with me that “multi trillions” of dollars have disappeared as a result of asset declines, you have to actually address the counterpoints I’ve made to that argument. That’s how this “debate” thing works.
Rich
Time will tell as we are all
Time will tell as we are all talking about where this will go from this point in time on. But history suggests that a senior currency like the US$ will be stronger relative to other currencies for most of this business cycle. Wages are sticky, so they tend to resist declining in a recession. But that doesnt mean they wont. No one is arguing that assets have not declined thus far. Now the question is “How will this effect the economy?” The forces of the market and the govt are now at odds with eachother.
My contention is that “Feeling less wealthy”, is not a luxury that someone who’s been unemployed for 8 months or was hoping to retire in a few years really has. To those that are relatively young and/or safely employed, loss of wealth is more psychological since they have a reliable source of income to rely upon. Or, so they believe. This is not the case for the unemployed and near retirement crowd. I would consider that Baby Boomers fall into this catagory. And they’re the driving demographic/econmic force of our nation. If they’re scared, they will not spend nor will they borrow. If the govt manages to get them more money, I think they’ll save it. Where is the demand at this point? Without velocity, how can money supply be inflationary? Without the multiplier effect or wage increases where is it going to be deployed to cause inflationary activity? Perhap the banking system and/or treasuries or gold? That’s my bet. But that’s not inflationary. Anyway, As the global economy constricts, where’s the demand outside the USA?
I think the govt’s attempt to regain inflation will be very difficult for them despite their best efforts. They’d need to ruin the US$ to do it. And it would take a while to get there as they’d try to do it in stages to avoid collapse.
peterb wrote:They’d need to
[quote=peterb]They’d need to ruin the US$ to do it. And it would take a while to get there as they’d try to do it in stages to avoid collapse.[/quote]
I think it’s going to be like someone firing a gun that isn’t working. They fire several times (over the course of three or four years) but nothing happens (prices don’t inflate). Finally, in total frustration they load it up with extra powder, then look down the barrel while pulling the trigger to see what is wrong, and blammo.
peterb wrote:Time will tell
[quote=peterb]Time will tell as we are all talking about where this will go from this point in time on. But history suggests that a senior currency like the US$ will be stronger relative to other currencies for most of this business cycle. [/quote]
This argument is common. It reminds me of the “everyone wants to live in San Diego” rationale during the housing bubble. Sure, many people want to live here because it’s great. But that doesn’t justify infinitely high home prices.
The “senior currency” argument seems like the same logic. Yes, there are reasons that the US is the reserve currency and the world is certainly geared that way. But that doesn’t justify an infinite amount of abuse and purposeful debasement of the dollar. Just like with housing, one day they will say “too much.” My suspicion is that the government will not stop until it’s hit or crossed that line.
Also, I reject the “US is bad but other countries are even worse” argument. (Not that you made it in this post, Peter, I just thought i’d mention it as it’s similarly themed). I’m sorry, but it is our banking system that is the epicenter of this whole mess. It is our economy that became dependent on debt and exports and just selling assets to each other. There’s no way we come out of this first. Our exporters might have to repurpose their means of production — we have to build ours from the ground up.
Rich
DaCounselor wrote:
I will
[quote=DaCounselor]
I will take it one step further and add that job security/economic optimism is also a necessary component of such inflation.
[/quote]
History disagrees.
Neither job security nor economic optimism were present during the period of highest inflation rates of the past half-century (late 1970’s /early 1980’s).
“History disagrees.
Neither
“History disagrees.
Neither job security nor economic optimism were present during the period of highest inflation rates of the past half-century (late 1970’s /early 1980’s).”
___________________________
Very true, FSD. I think the variables are so drastically different now, however, that a comparison to the late 70’s is not going to be very instructive. It does not appear that we are going to see inflation fueled (at least in part) by low productivity/lack of goods as we saw in the 70’s. Something is going to have to replace that driving force, in my opinion increasing job security/economic optimism will have to be the substitute in this day and age. And such optimism will have to be awfully stout and enduring to drive inflation beyond the goals of monetary policy. Assuming the Fed, unlike in the 70’s, prioritizes restraining inflation to mild/moderate increases.
DaCounselor wrote:I think the
[quote=DaCounselor]I think the variables are so drastically different now, however, that a comparison to the late 70’s is not going to be very instructive. It does not appear that we are going to see inflation fueled (at least in part) by low productivity/lack of goods as we saw in the 70’s.
Something is going to have to replace that driving force, in my opinion increasing job security/economic optimism will have to be the substitute in this day and age. And such optimism will have to be awfully stout and enduring to drive inflation beyond the goals of monetary policy. Assuming the Fed, unlike in the 70’s, prioritizes restraining inflation to mild/moderate increases.[/quote]
The 1970s inflation was driven by excessive growth in the money supply, as are all long-term inflations. And we’ve got plenty of that right now, so there is no need to replace any driving force.
Also, imho restraining inflation isn’t a high priority for the Fed… as long as long bond yields stay low they really don’t give a rat (as evidenced by their rate slashing even as CPI was up 5.6% yoy). And that was then — now they are truly panicked and they don’t want to make the “policy error” (as Bernanke puts it) of raising rates too fast, as they feel happened in the Depression and Japan.
Rich
“The 1970s inflation was
“The 1970s inflation was driven by excessive growth in the money supply, as are all long-term inflations. And we’ve got plenty of that right now, so there is no need to replace any driving force.”
____________________________
Disagree. Not that I’m right…:) But I’m a cost-push guy re the 70’s. If you are in Friedman’s camp, that’s cool, there is certainly room for differing opinions re causation. I think a few oil embargoes, mafioso back-room trade union negotiations (ie wage spirals), and lower productivity and availability of goods were the causative factors in the 70’s. Now I don’t know offhand the ratio between the CPI and M1 in the 70’s, but I suspect CPI outpaced M1 by a fair margin, which I would also add to my quiver.
Good stuff, these debates. Put me down in the deflation-to-moderating-deflation-to-very-mild-inflation sequence camp through 2012.
Rich. Your simple, clear
Rich. Your simple, clear writing style shines through in this article. Well done filling in alot of details.
The question I have whenever I hear “deflation” and “inflation” is this – exactly what is going to change ?
Lets say in 3 years, we have a significantly larger money supply, yet prices don’t come up at all? Were you right in your inflation call ? That isn’t a “lawyer question” (one to which I already know the answer). And how does one measure credit destructions. I’m not sure how one measures credit destruction so calls of inflation or deflation based on that credit destruction don’t seem useful.
I think you are right in your prediction of how the Fed/Treas/Gov is going to respond to this situation, but I’m not sure it will have enough of an effect it will have on prices to bring a stagflationary situation.
You mentioned that inflation strikes the higher demand sectors the most. Thus, If there is little demand for anything, and people are saving and/or paying back debts, the price effects of monetary inflation are significantly reduced.
I’ve heard it said gold does well during inflation as it’s supply is steady. I have also heard that gold does well during price deflation because it acts like money, which increases in value as the value of commodities drops due to lower demand. And during moderate deflation, it falls by the wayside, unnoticed.
Getting to the bottom line – where to put your money for the next year / few years?
Another way to ask the
Another way to ask the question.
When you do a financial analysis to determine if an investment makes money, you always adjust for tax, and inflation. (Also, compare to alternative investments, which also need to be adjusted for tax & inflation).
So if I invest $100 for 1 year and it returns $110, and I pay 40% tax on the $10 gain, it makes me 6%. But if inflation is 5%, it represents a 1% increase in spending power.
Here, inflation means “what is my spending power?” which is really not a question of supply, but price.
Even in light of increased money supply, I’m not sure I should be using a positive number in calculations such as this. I’m screwing with examples to understand this more. Back in a bit.
error – change
“during
error – change
“during moderate deflation” to
“during moderate inflation”
Rich. Your simple, clear
Thank you sir!
I would say no. Though my main argument is that prices of SOME stuff will rise, maybe a lot.. prices of other stuff may still decline. More below. But generally, if the prices of stuff that people need are down in 3 years in dollar terms, I would look back and say mine was generally speaking a bad call.
But see, there is demand. Are people going to stop buy food? Gas? Etc? We are in a severe economic slowdown right now but I still get caught in traffic and have to wait at restaurants. There’s still people at the malls, though buying less. Demand is declining, and I believe it will especially decline for discretionary goods and stuff bought on credit (to the extent credit stays tight). But demand hasn’t disappeared by any stretch. Not to mention that we are vying for many things (food, energy, industrial materials) on the world stage, and unlike us, a lot of those people have savings they can dip into.
To avoid compliance hassles I am going to steer clear of all questions about how this pertains to investment strategies… sorry bout that. (Email if you want).
Rich
Your statement that money is
Your statement that money is created but never destroyed not only makes no sense but is incorrect. What you are implying is that the Fed will ‘print’ money but once it’s in existence it remains in existence? Nonsense.
The problem is in Part II of your article: debt default. When Bob defaults on his $10, it most certainly is destroyed. It shows up as a -$10 on Alice’s sheet and she has to deduct that from her supply. When you see a bank ‘writeoff’ $10 billion at a time that is money taken out of circulation. Yes the Fed can print more, but what has been going on the last few years is the money destruction has been far greater than the money created on the Fed’s balance sheets. Sure we know the goals of the Fed are to reflate but so far they haven’t done it.
From 2001 to 2008 household debt increased $6.5 trillion. That bubble has burst and everything the Fed is giving to banks (and AIG and credit card companies) is going down a black hole as debt defaults. So the Fed can print more until all the black holes are filled and then you can start calling it inflation. The problem is it will take many many more trillions to do so and the bond market will puke well before that hole is filled.
Yes, kiihei, you understand,
Yes, kiihei, you understand, as you say about that guy:
“Your statement that money is created but never destroyed not only makes no sense but is incorrect. What you are implying is that the Fed will ‘print’ money but once it’s in existence it remains in existence? Nonsense.”……
Yes.
Like I say, there is a “window”. Likely, at some point, the stimulus measures will generate some rebound in the economy, even if short-term, it will have the effect of stabilizing and increasing prices/costs, causing the “window” to shut. But, now, markets are demanding more dollars.
The worst of the deleveraging which is going on, is with unemployment. It simply can’t be allowed to continue at the rate it is, especially when there are things which are needed to be done -infrastructure, education, healthcare, energy, etc.
Plus, this has global impacts. We need other countries, and they need us, but they are looking for us to take leadership. The meltdown began with us, and our markets need to be stabilized first. Sure, it won’t solve everything, as we do have some systemic problems which will need to be addressed, so there will be a second test for us.
http://josephoppenheiminvesting.blogspot.com/
kihei wrote:Your statement
[quote=kihei]Your statement that money is created but never destroyed not only makes no sense but is incorrect. What you are implying is that the Fed will ‘print’ money but once it’s in existence it remains in existence? Nonsense.
The problem is in Part II of your article: debt default. When Bob defaults on his $10, it most certainly is destroyed. It shows up as a -$10 on Alice’s sheet and she has to deduct that from her supply. When you see a bank ‘writeoff’ $10 billion at a time that is money taken out of circulation. Yes the Fed can print more, but what has been going on the last few years is the money destruction has been far greater than the money created on the Fed’s balance sheets. Sure we know the goals of the Fed are to reflate but so far they haven’t done it.
From 2001 to 2008 household debt increased $6.5 trillion. That bubble has burst and everything the Fed is giving to banks (and AIG and credit card companies) is going down a black hole as debt defaults. So the Fed can print more until all the black holes are filled and then you can start calling it inflation. The problem is it will take many many more trillions to do so and the bond market will puke well before that hole is filled.
[/quote]
No, debt defaults do not destroy money. It was already deducted from Alice’s “supply” when she lent it. The money is still circulating in the economy, as I explained in the article.
It’s true that a bank will have to write off the loss and will have to lend less in the future, but no money was destroyed. I explained this in detail in the article.
Now, paying back debt (as opposed to default) in a fractional reserve credit transaction does destroy the money… if the money was lent into existence, it can be paid back out of existence.
And putting those two things together, if an old loan is paid back, and the bank can’t replace it with a new loan because it had to write off bad assets, the money supply could decrease.
But, that’s not happening. The money supply is increasing, and it is increasing fast.
I’m kind of baffled by the people on here insisting that the money supply is decreasing, when there is ample data to show it’s increasing, and increasing fast.
http://research.stlouisfed.org/fred2/categories/24
Rich
“Now, paying back debt (as
“Now, paying back debt (as opposed to default) in a fractional reserve credit transaction does destroy the money… if the money was lent into existence, it can be paid back out of existence.”
This is absurd! You just said that if you actually pay the debt back money is destroyed but if you default the money isn’t destroyed.
So we should just have the banks do a mass default to greatly increase the money supply. I mean, the stated goal of the Fed is to increase the money supply, right? Until you grasp the absurdity of this statement there is no more debate.
kihei wrote:Until you grasp
[quote=kihei]Until you grasp the absurdity of this statement there is no more debate.
[/quote]
Sounds good to me.
Kihei,
First off, show a
Kihei,
First off, show a little respect to Rich. The guy posts great information for all of us here free of charge. He also generously offers some of his time to respond to questions. He deserves a little appreciation and respect…think of your posting as a visit to Rich’s house and treat him accordingly.
Since he’s not going to respond:
<>
How much does it cost to pay back $10? Answer: $10. How much does it cost to default? Answer: Nothing. So, yes, paying back money in a fractional reserve system may mean money is destoyed if it is not lent out again, but in defaulting, the money has effectively been spent elsewhere already, so money isn’t destroyed.
Pot, meet kettle.
Stan
kihei, read Rich’s “Debt
kihei, read Rich’s “Debt Default” section again. It answers the question you have about the Alice & Bob example. Remember that this example is outside of a fractional reserve lending system.
At the beginning of the example, Alice had $10, Bob had $0, and Starbucks had $0. The total amount in the system is 10 + 0 + 0 = $10.
At the end of the example, Alice has $0, Bob has $0, and Starbucks has $10. The total amount of money in the system is 0 + 0 +10 = $10.
Within a factional reserve lending system, the banks have the ability to create money. When a bank gives out a loan, it creates credit and money at the same time. As people pay back their loans, that credit & money is destroyed.
When a bank “writes off” a loss, the money is NOT destroyed. That money is still somewhere in circulation (possibly at Starbucks).
As you point out, when a loan defaults, the bank does take a hit on their balance sheet. This reduces the amount of money that the bank can potentially lend/create. So the “write offs” aren’t destroying money, they are simply preventing new money from being created.
Suppose a bank’s balance sheet is bad enough where it can’t make any new loans. This means that it can’t create new money. Now suppose you pay off a loan you received from the bank. That money is taken out of circulation and put in the bank. That money is destroyed. And since the bank isn’t giving out new loans, there’s no new money to replace it. Therefore, the bank’s net effect on the system is the destruction of money.
Lance, great explanation —
Lance, great explanation — thanks.
Rich
Lance, great explanation —
Lance, great explanation — thanks.
Rich
Thanks, I didn’t realize that you had answered the question while I was typing.
P.S. Lance is my brother. Me llamo Lee 🙂
ltokuda wrote:
Lance, great
[quote=ltokuda]
Lance, great explanation — thanks.
Rich
Thanks, I didn’t realize that you had answered the question while I was typing.
P.S. Lance is my brother. Me llamo Lee 🙂
[/quote]
Well, you answered it a lot better and more patiently than I did, so thanks for that.
Sorry about the name mixup… I saw those two names together somewhere once, and I hadn’t had my coffee yet when I posted so there must have been some neuronal misfiring going on.
Rich
Great articles, Rich.
Great articles, Rich. Thanks! I’ve read them a few times and I believe your analysis is very sound.
It seems like one of the main points of contention here is the title itself: “No Deflationary Spiral Forthcoming”. It is arguable that the “deflationary spiral” has already started and will probably continue throughout the year. But my interpretation of the title is that “We Won’t Have A Deflationary Spiral Like The One We Saw In The Great Depression”. I believe that’s the main point of your papers and I think that’s a very reasonable prediction.
ltokuda wrote:Great articles,
[quote=ltokuda]Great articles, Rich. Thanks! I’ve read them a few times and I believe your analysis is very sound.
It seems like one of the main points of contention here is the title itself: “No Deflationary Spiral Forthcoming”. It is arguable that the “deflationary spiral” has already started and will probably continue throughout the year. But my interpretation of the title is that “We Won’t Have A Deflationary Spiral Like The One We Saw In The Great Depression”. I believe that’s the main point of your papers and I think that’s a very reasonable prediction.[/quote]
Thanks Lance. Hopefully people are reading past the four-word title and into the introduction to the article, where I the premise is (as you noted) that a long term, depression-like deflationary spiral, while being predicted by many people, is exceedingly unlikely.
It seems to me like the big points of contention are:
– People conflating money and credit.
– Focusing on real declines in private sector economic activity, and disagreeing that the govt can debase even faster than that. This is a valid point of disagreement, because when it comes down to it, that second clause is a matter of opinion (though I personally believe that there is ample reason to hold that opinion).
Rich
Maybe this is a question for
Maybe this is a question for Rich, or maybe for Davelj, but how much money is being created by the bank’s lending? Banks are taking huge losses right, and those losses mean they have less capital to lend. If they loose too much money the become insolvent and the FDIC steps in. The question then is what are the ratios that banks are using to create money, 10-1? 5-1? 100-1? and is that level slowing?
I ask more becuase I wonder if this is being taken into account in the Federal Reserve system. When things eventually do get better, and banks start lending again,…… (you can see where I am going with this.)
The question then is what
The question then is what are the ratios that banks are using to create money, 10-1? 5-1? 100-1? and is that level slowing?
I have some related questions. Does the M1 measure the amount of money in the system, excluding money created by the banks? And does M2 approximately measure the total money in the system (including money created by the banks)? Would the ratio of (M2 / M1) answer DWCAP’s question?
DWCAP wrote:Maybe this is a
[quote=DWCAP]Maybe this is a question for Rich, or maybe for Davelj, but how much money is being created by the bank’s lending? Banks are taking huge losses right, and those losses mean they have less capital to lend. If they loose too much money the become insolvent and the FDIC steps in. The question then is what are the ratios that banks are using to create money, 10-1? 5-1? 100-1? and is that level slowing?
I ask more becuase I wonder if this is being taken into account in the Federal Reserve system. When things eventually do get better, and banks start lending again,…… (you can see where I am going with this.) [/quote]
I actually wasn’t following this thread until now, so I just saw this.
The easiest way to think about how banks create money is to assume a steady-state economy with a few banks (doesn’t matter how many) where a new bank is started up. If the new bank starts out with $10 million in equity then it will ultimately be able to make loans of roughly $80 million (this new bank will also have some cash, securities and other assets, but loans, on average, will end up at around $80 million). On average it will take 3-5 years for the bank to leverage its equity up. So, in this closed system the new bank has created $70 million of new money (via credit) through new loans that otherwise could not have been made by the other banks (as we assume they are already fully leveraged up).
As a general aside, so long as credit is increasing at no greater than the nominal increase in GDP, then there really isn’t a problem with fractional reserve lending or the inflation effects thereof. The problem is that over the last 15 years credit has expanded at a rate much greater than nominal GDP… and here we are. The Officialdom wants the banks to grow their balance sheets with the TARP money but this, of course, is insane. The TARP money should be used as a cushion to write assets down and keep lending only to good customers, of which the majority are. The Officialdom should instead be trying to keep bank lending flat – that is, neither increasing nor decreasing – as we work through this crisis. More credit for marginal borrowers is not the answer. We just need to keep the credit flowing to the stronger borrowers and let the marginal borrowers go under. The banking system can suck up considerable losses through the net interest margin over time. But it can’t take all the losses on at once. In time, this ship will right itself, but the next couple of years are going to be quite painful.
Well stansd I am simply
Well stansd I am simply trying to correct a glaring fault I keep seeing. We operate in a fractional reserve banking environment. The TOTAL money supply includes the money issued by the FED and by all the banks under that fractional reserve environment. It is simply wrong to believe that a default, whether issued under a full reserve or fractional reserve system, does not destroy money. That money is destroyed, and can not be lent out again, until new money comes into the banks reserves (assuming the bank was lending at maximum leverage).
Money (credit) is constantly being created and destroyed. The issue is over a given timeframe is it being created faster than it’s being destroyed. I would claim that’s it’s being destroyed (deflationary) since around 2006. How soon until reflation takes hold? Well that’s the premise of the title – ‘No deflationary spiral forthcoming’. If it takes two more years to get back to inflation, but real estate is another 15% less and stocks are 30% less, would that five year period of time be called a deflationary spiral. It’s not a spiral into total collapse, just a depression scenario like in the 30s.
It would appear in order to be competitive again there has to be a collapse in commercial real estate and wages in order to bring back manufacturing so that it’s more cost-effective to produce here than elsewhere. Either that or to destroy the manufacturing base of the other countries, like in WWII.
Kihei,
To your first point,
Kihei,
To your first point, you can have a rational discussion in a respectful manner.
To your argument, in the case of default, where do the dollars that were originally lent go? Answer: into another bank, where they can be relent. Therefore in default, money could still be destroyed, but only if that bank doesn’t lend. This is the same scenario in a repayment-it’s just a different bank.
Stan
The lender experiencing the
The lender experiencing the default is now impaired to lend more. If this is a trend, then the lenders will be afraid to lend when they have growing defaults. Like now.
Suppose I sell my house and take the money and buy gold. The guy who buys my house defaults and walks away. The defaulted lender now has less reserves to lend from and the borrower has had his credit destroyed for any further borrowing. So that’s two losers for one gainer. And the one gainer has his gain where the system cant utilize it. This looks like money has been reduced from the system to me. But even if I put my money back in a bank somewhere, it would help that bank, but not the other lender nor the borrower who defaulted on that lender. With fractional reserve lending, the amount of money created in credit is orders of magnitudes greater than the standard money supply. Destroy credit and you’ve got a lot of money to make up for in the system. I think that’s what the govts trying to do right now.
Big thanks! The article has
Big thanks! The article has solved many of my own ‘conundrums’.
Now at least I know we’re pretty much screwed no matter what we do with our savings:
Option 1: We don’t buy a house and let our few savings lose their purchasing power.
Option 2: We purchase an overvalued house and hope for the best when mass layoffs are becoming a daily routine (maybe it is a good time to get a mortgage with fixed interest rates…)
Any attempt by the government
Any attempt by the government to cause significant inflation would backfire severely.
In today’s global economy we won’t see any type of wage inflation in this country. Companies can simply outsource jobs if wages begin to inflate at all.
Therefore any price inflation of goods would not be accompanied by wage inflation. This would have catastrophic consequences as even someone with a job would eventually go broke/default/etc due to rising prices. This would lead to an even greater recession/depression.
There’s no way to inflate out of this mess without making it worse.
I’m sorry Rich, but your
I’m sorry Rich, but your examples from section 2 are pretty much all flawed due to the fact you are balancing your equations as:
Assets = Liabilities
Not as it should be:
Assets = Liabilities + Owners Equity
Taken as it should be, the desert island economies money supply has in fact grown because while the owners of the credit notes do in fact not have the $10 cash, they have no liabilities, hence their owners equity has increased by $10.
By accounting rules they are now free to draw upon that $10 owners equity to pay themselves dividends or pay liabilities. While the island may only have a single $10 bill, the real world has this money/credit available to be dispersed, and it is dispersed, adding to the money supply. Put another way, the assets column (credit note) is reduced every time a liability is paid or o.e. is reduced.
Clearly this interaction shows credit = money.
Therefore, if the note is not paid back, the assets column disapears, as does the owners equity column, while the liabilities column remains unchanged.
If $2 in liabilities have been paid out, and $1 in dividends, the creditor (bank) is now showing a loss of $3.
Taken further, a $10 bill is really nothing other than a note saying that this piece of paper can be used to purchase $10 worth of stuff. All those individuals on the island are free to trade the $10 notes they received as creditors to buy stuff as well (credit cards, equity loans, mortgages, etc). Again, credit = money. All these notes = money at this stage. However, if there is a sudden mistrust in the note writers ability to actually hand over the $10 bill, this destruction of credit notes takes money out of the system, reducing the money supply.
You see, not only physical money (1 $10 bill) was trading hands to buy stuff, but credit (3 notes for $10) was as well. This equals a larger money supply than does a single $10 bill. In fact the money supply in this scenario has been reduced by 75%. It will take 3 $10 bills being printed to bring the money supply back to where it was.
Now, as for your suggestion that we are not a nation of savers making the government free to fire up the printing presses, I also completely disagree. 401k, pension plans, etc all constitute a form of savings, and there will be bloody murder (probably literally) if politicians inflate the value of these savings away.
Spitfire:
I told myself I
Spitfire:
I told myself I wasn’t going to spend any more time on this thread but you framed your points in an interesting manner so I couldn’t resist.
You basically start off by implicitly redefining money to include financial assets, and then offer that as proof that credit = money.
If the holder of a $10 credit note wants to, say, go buy a six pack of beer, he cannot buy the beer with a credit note. “Accounting standards” may say he can use that as equity to back a purchase of beer — but he cannot actually take the IOU to the store to buy beer. This is why I say it’s not money.
If he wants to buy beer, he has to do one of the following:
1. Sell the note. In this case, he transfers ability to purchase/money away from the buyer of the note.
2. Borrow against the note from a non-bank. In this case, he also transfers ability to purchase/money away from the lender (with the intent to switch it back in the future).
3. Borrow against the note from a bank. In this case, the bank can actually lend new money into existence via the fractional reserve system, and new money IS created with the note as fodder. However, this is an example where a credit transaction happens to create actual money — that doesn’t mean that all credit transactions do so. Furthermore, the money created shows up in the monetary aggregates. (So in our desert island economy, another $10 bill would appear).
Equity in a financial asset is not money. This was the claim made by all the people who said don’t worry, America has a high saving’s rate — look at all the home equity they have. But like I indicated above the purchasing power of that equity can only be tapped by transferring someone else’s purchasing power to you in exchange for the equity, OR by using it as fodder for the further creation of real money via the fractional reserve system.
Incidentally, you seem to only count equities and not liabilities. In the example, for everyone who gains owner’s equity in the form of a credit note, there is someone else with an offsetting liability. So if I am understanding your description correctly, even using your framework there is no increase in the money supply
As far as this statement:
“401k, pension plans, etc all constitute a form of savings, and there will be bloody murder (probably literally) if politicians inflate the value of these savings away.”
Are you saying that deflation would be better for 401ks (which are presumably composed mostly of stocks) than inflation? I refer you to the 1930s if so. Deflation is absolute murder on nominal stock prices.
The US is a net external debtor. Deflation (an increase in dollar purchasing power) makes the real value of those foreign debts rise, thus increasing real costs of paying them off. Inflation does the opposite and is far more politically palatable.
Finally, on your followup post: per the proxies put out by some bloggers, eg http://www.nowandfutures.com/key_stats.html#m3b , M3 looks similar to other monetary aggregates in that it flattened out earlier in the 2008 and is now growing like a weed.
OK, signing back off again…
Rich
Further thoughts:
M2 and MZM
Further thoughts:
M2 and MZM are great for tracking money supply as in your Starbucks lattes example:
“But debt defaults do not destroy money. Let’s look at an example in which Alice lends Bob $10. Simply put, Alice gave her $10 to Bob, with the understanding that Bob would pay it back.
But Bob doesn’t pay it back — he spends it on lattes at Starbucks and then defaults on the loan. Alice is out of luck — but you will notice that no money has been destroyed. The $10 is sitting there in the till at Starbucks, soon to make its way elsewhere throughout the economy.”
But MZM and M2 fail to account for credit like M3 used to (from wikipedia):
“Prior to this discontinuation, M3 had included M2 plus certain accounts that are held by entities other than individuals and are issued by banks and thrift institutions to augment M2-type balances in meeting credit demands; it had also included balances in money market mutual funds held by institutional investors.”
Again, the $10 bill is sitting in the till, but Alice has lost $10 in Owners Equity, money that is now taken out of the money supply.
Spitfire, thanks. Your
Spitfire, thanks. Your explination makes complete sense to me. And I think this is what we’re seeing right now in the economy.
It dawned on me that a very simple way to look at this from a day to day perspective is that without the availability of credit…how many people could buy their cars with cash from thier personal holdings? The same question for house purchases. Or anything that’s over $10K in price? I think if people view it this way, it makes it simply clear how important credit availability is to our system. And the ability to sustain the payments associated with the debt.
Thanks Rich for your
Thanks Rich for your articles…
This is the best description I have read about our money and credit systems since I read ‘The Biggest Con: How the Government Is Fleecing You’ by Irwin Schiff (Peter’s father) back in the 80’s.
As for the stock market as I see it, for better or worst is like the fractional banking system. Although a very small percentage of stock are sold at a higher/lower price, the remaining unsold stocks rises or lowers in value. Thus, it does not consume or create true wealth until a transaction is made. At that point true value has been assessed and transferred. The same is for housing at a slower rate.
I feel all this talk of the loss of value in the stock market is hogwash for most. The stock market has not dropped below the 2001 level when the hyper inflation to housing was created. It was purely inflated due to inflated home prices used in mortgages to buy consumable goods that don’t last much more than 5 years. It would be my guess that if everyone with a substantial 401K looks at their 2002 balance and compares it with today’s balance, today’s balance would be still higher. It wouldn’t surprise me if you subtract out any deposits between that time you still will be ahead with a decent rate of return.
Even my house I bought in ’97 for $150k is worth $350k today after being as high as $650k in 2005. That’s about a 13% annual return.
Those who sold stocks from 2003 to 2008 probably made money. Those who bought and held stocks from 2003 thru 2008 probably lost money. Those who bought well before 2003 are probably still positive.
As for 401k’s, those who are ready to retire (2-5 years) should not have been impacted greatly due to their exposure the stock market should have been minimal (< 20%) if the portfolio was properly managed. Your term of velocity is 'Cashflow'. Companies and individuals with positive cashflow will survive. However, one may need to move their wealth around different vehicles to reduce the risk of being a deflationary cycle. First was housing, then the stock market. I am thinking the commodities, including Gold will be next. Oil was the first to cave due to highly velocity (use). The others will follow because the demand will be reduced from individuals needs due to recession and unemployment. Once that happens, we will be in for your inflationary rise. The Government has to make up for the fiat inflation cause by mortgage lenders over the past 7 years to keep the economy running. IMHO it has been the capital gains tax breaks in 1997 that initially started this housing bubble. http://www.nytimes.com/2008/12/19/business/19tax.html
Thanks,
Luck In OC
Hi Rich, thanks for the
Hi Rich, thanks for the reply.
For starters I agree with you in that I don’t believe we are in for a deflationary spiral.
“Are you saying that deflation would be better for 401ks (which are presumably composed mostly of stocks) than inflation? I refer you to the 1930s if so. Deflation is absolute murder on nominal stock prices.”
No. Both are bad as of now. The reality is that DOW 14000 was overpriced, and DOW 8000 is a better reflection of actual worth. Sure everyone was happy and feeling rich, but as we have now seen, that actual value was never there. How else does an entire market collapse 40% unless it is a bubble, it is overpriced, or it is overvalued? Housing anyone? Commodities anyone?
Stability is the name of the game now. Inflation as you suggest will be completely socially unacceptable. It is not good for Zimbabwe and it was not good during Weimar. A deflationay spiral would be equally unacceptable.
“The US is a net external debtor….”
So we pay for this debt by raising taxes or hyperinflating? Neither good, both economically destructive. I suggest we throw every politician who ever voted for deficits be thrown in a debtors prison until the US has paid it’s debt in full!
As for our argument on whether or not credit is money and an actual part of the money supply:
Money is defined as: “4. any article or substance used as a medium of exchange, measure of wealth, or means of payment, as checks on demand deposit or cowrie.” (dictionary.com)
A credit note as long as both parties involved in the transaction consider it to be a “means of payment” becomes money.
The best example available right now is the concern over the credit markets. Note that it is not a concern about the amound of physical currency, but rather credit. Credit markets being frozen like they are has made a gigantic dent in our ability to conduct business. Why? Because there is suddenly no money available to finance projects, expansion, buyouts, takeovers, etc.
“If the holder of a $10 credit note wants to, say, go buy a six pack of beer, he cannot buy the beer with a credit note. “Accounting standards” may say he can use that as equity to back a purchase of beer — but he cannot actually take the IOU to the store to buy beer. This is why I say it’s not money.”
California is issuing IOU’s as tax refunds this year. We’ll see if those are tradeable as money or not, but my guess is that there will be trade in them.
Seriously though, the example started with the desert island scenario. With only 1 $10 bill floating around, we can quickly see that the credit notes can quickly become money to be bartered no differently than the $10 bill. Look at CDO’s. Hey Joe, you wanna buy some debt obligations?
With 3 credit notes being used as money, and 1 $10 bill the desert island economy is humming with trade compared to the desert island economy with only 1 $10 bill. Why? Because the money supply is 4 times as large!
To summarize: Banks have been the enablers of credit = money. How? What assets can you put up as collateral for your loan? Bank client hands over balance sheet to loan officer -> The magic of Fractional reserve lending -> increase in money supply! All because someones balance sheet shows assets.
This is exactly what you state at the end of this statement:
“Equity in a financial asset is not money. This was the claim made by all the people who said don’t worry, America has a high saving’s rate — look at all the home equity they have. But like I indicated above the purchasing power of that equity can only be tapped by transferring someone else’s purchasing power to you in exchange for the equity, OR by using it as fodder for the further creation of real money via the fractional reserve system.”
Which nullifies equity in a finacial asset not being money. Equity in a financial asset = credit = money.
Rich,
Thank you for putting
Rich,
Thank you for putting in the time on this post. It seems to me that there is a flip point where the government loses control of the whole process. At that point, either inflation goes rampant and/or the currency fails (everyone loses faith in the currency itself). If history is to repeat itself, the more the current government tries to buy its way out of deflation, the stronger the flip will be. I suspect that the dollar is already trapped, meaning no matter what is done, it will fail–perhaps to a great degree, perhaps to a not so great degree. In the end, the only way out of this that I see is to become less dependent on credit. This will take a fundamental reworking of our economic structure and in the long run be a good and healthy thing.
Thank you again,
Zerospeed.
Seriously though, the
Seriously though, the example started with the desert island scenario. With only 1 $10 bill floating around, we can quickly see that the credit notes can quickly become money to be bartered no differently than the $10 bill.
Spitfire, I think you need to re-read rich’s articles very carefully. You seem to be confusing the issues. I know Rich doesn’t want to spend more time on this so I’ll try my best to clear things up.
Rich is NOT arguing that credit can never be equal to money. In fact he points out that in today’s fraction reserve banking environment, banks create credit and money at the same time.
But that does NOT necessarily mean that credit IS money. In the island example, you point out that “credit notes can quickly become money”. Think about that. You’re saying that credit notes have the POTENTIAL to become money. You’re not saying that credit notes MUST become money. Its entirely possible that the credit notes will never become money. This is key because is shows that the statement “credit = money” isn’t always true. In the modern banking system, credit and money are created at the same time so its easy to confuse the two and think of them as the same thing. Rich’s article points out that there are subtle differences.
The assertion that “equity in financial assets = money” is wrong for the same reason. In some cases, equity in a financial asset might be treated as money. In other cases, it might not.
I still think you don’t fully
I still think you don’t fully appreciate that, for a long time, people’s ability to spend equaled their willingness to spend, and it is no longer the case
and
no matter how much M2 is flooded into the system, if banks hesitate and/or refuse to lend, “destruction” (vs expectations) occurs.
Nonetheless, I agree with your point that the gov’t will not allow protracted deflation. Much like the prelude to a tsunami, as you point out at the end of Part I, the more protracted the deflation (receding tide), the more intense the inevitable reflation/inflation.
It remains to be seen how proactive policy will be on the slingshot.
I don’t think anyone alone has this all figured out but, from many perspectives, we can all learn from each other. As such, I’m grateful that you’ve stimulated so many.
OK, Dr Keen has explained
OK, Dr Keen has explained this in a way that I can understand and is logical. It’s a bit long, but worthwhile for those looking for more causal relationships and accurate measures of what’s driving the economy:
http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/