PDA

View Full Version : U.S. Not Out of the Deflation Woods Just Yet



Jim Nickerson
02-23-10, 12:37 PM
http://www.bloomberg.com/insight/out-of-deflation-woods.html

"Ask most economists if 2009's mild deflation will continue this year and their answer is: absolutely not."


The link concludes with: "Commodities, just like jobs, are expected to rally this year. The experts say a decline for either one of them is a low probability event."

"Commodities, just like jobs, are expected to rally this year. The experts say a decline for either one of them is a low probability event."

From David Rosenberg's today's note.

"As San Francisco Fed President Yellen explained in her well-timed speech yesterday, “the economy will continue to operate well below its potential throughout this year and next … it seems quite possible that core inflation will move even lower this year and next.” You know what that means don’t you? No top-line momentum for the equity market and a low inflation anchor for the Treasury market (and by extension, the Canadian government bond market as well). It would not surprise us if we finished the year well below 3% on the 10-year Treasury note yield."

TNX is 3.727% as I write

vinoveri
02-23-10, 01:18 PM
The Fed is just talking their book in order to justify their free money policy IMO.

While I wouldn't take a large bet on which way commodities will go in the next 10 months, one thing I am increasingly certain (thanks to the many years at iTulip), and which now seems patently obvious ...

the cost in $ of virtually everything "real" (i.e., not bonds and currencies) will, over the mid-long term, accelerate upwards. Housing may take a longer time given the inertia and illiquid market, but for everything else, it's bring us frogs to a boil, just slow enough. When organic growth resumes (if it does) in 2-3 years, asset markets booming, gas is $5 gal and starting average salaries are $100k, everyone, but those saving fools, will be cheering on the success of monetary policy :eek:

This is as the austrians point out, the money is doled out to those at the top (as we're seeing now with the Fed Funds at 0% and various fiscal handouts/backstopss), and this money will find its way into real assets. Friedman was right about this (whether you want to call it inflation or currency depreciation, some of the results are the same. Theft it is.

FRED
02-23-10, 01:37 PM
Our forecasts of cycles of disinflation and inflation are based on an understandibg of how the system actually works, not the theoretical system they believe they learned in college in.

These guys still haven't figured out how the system works. Pathetic.

Jim Nickerson
02-23-10, 05:13 PM
Our forecasts of cycles of disinflation and inflation are based on an understanding of how the system actually works, not the theoretical system they believe they learned in college in.

These guys still haven't figured out how the system works. Pathetic.

What I find "pathetic" is hubris amongst peons.

Finster, who of course doesn't know "his ass from his elbow" on Saturday mornings after being up late Friday nights picking and grinning, for some weeks has projected in his FMO that by Fall the 10-yr notes ($UST) could be up 7-8% from where they currently are. I have no idea as to the efficacy of Finster's projections/predictions. FYI, looking at the projections for UST they are represented by figure in the third row and for instance in the table below in 32 weeks they are projected to be up .0808 (being black is positive) so up 8.08%. The time-frames are omitted from the first two tables, though they are the same for each row as depicted in the last two tables.

http://www.itulip.com/forums/attachment.php?attachmentid=2858&stc=1&d=1266960815

http://www.itulip.com/forums/attachment.php?attachmentid=2859&stc=1&d=1266960910

http://www.itulip.com/forums/attachment.php?attachmentid=2860&stc=1&d=1266962632

http://www.itulip.com/forums/attachment.php?attachmentid=2861&stc=1&d=1266962632
http://users.zoominternet.net/~fwuthering/FFF/FinsterMarketsOutlook (http://users.zoominternet.net/%7Efwuthering/FFF/FinsterMarketsOutlook) The link explains Finster's thinking on these projections. Now how to adjust "Finster dollars" into how US dollars will translate at these future times is beyond my pay-grade (my pay-grade is zero).


Aside from the shorter-term suspicion that unemployment has not peaked, I want to be clear that my main concern about the employment situation is with servicing debt, not providing for the basic needs of the population. I'm certainly not talking about Malthusian macroeconomic shortages or an inability for our nation to support itself. It is the gap between cash flows and household debt service that strikes me as problematic.
(http://www.hussman.net/wmc/wmctmplt_withRelatedLinks_g74010304701631922383643 83511860966.gif)
On the broader issue of supporting a growing population, it has historically been true (and is likely to continue to be true even in the event of further credit strains) that the needs of the U.S. population can be supported through productivity growth and to some extent by importing the output produced by cheaper foreign labor. In the long run, productive investment is the cornerstone of economic stability. Over the past decade we have greatly threatened that stability through the ridiculous misallocation of resources in speculative bubbles and unproductive "investments," but I am convinced that we will re-learn, painfully or otherwise, to better allocate our resources. My impression continues to be that the current deleveraging cycle will likely be a multi-year process that is presently far from complete.
[JN emphasis] http://www.hussman.net/wmc/wmc100222.htm

My position continues to be on all issues of prognostications is that I do not know who is correct. Mark Faber is to me a total bear on US notes/bonds, and he may be correct--someday. Besides the issue of being correct, there co-exists the issue of "timing." So if one's investment horizon is 20 years, what happens over the next year might not be critical; however, for shorter horizons relatively near-terms may be very important.

I think people who subscribe to their having average or above average intelligence should keep an open mind as to what might be the future with inflation, deflation, etc.

FRED
02-23-10, 07:18 PM
We were told "deflation!" in 2001 and didn't buy it. They told us we were stupid. Did deflation happen? In 2007 they screamed "deflation!" Did deflation happen? Today they again warn "deflation!" As the joke goes, "Sometimes I don't think you're here for the hunting." :D

metalman
02-23-10, 08:24 PM
tell me again, daddy. never get tired of hearing it... saved me a bundle of $$$.

stanley2008
02-23-10, 09:51 PM
We were told "deflation!" in 2001 and didn't buy it. They told us we were stupid. Did deflation happen? In 2007 they screamed "deflation!" Did deflation happen? Today they again warn "deflation!" As the joke goes, "Sometimes I don't think you're here for the hunting." :D

Fred,
Do you have any of your money in treasuries?
If yes then can you explain how you expect to maintain or increase that portion of your wealth that is in treasuries, given your certainty of inflation?

metalman
02-24-10, 07:47 AM
Ig
Fred,
Do you have any of your money in treasuries?
If yes then can you explain how you expect to maintain or increase that portion of your wealth that is in treasuries, given your certainty of inflation?

but the predicted inflation is already here... for all to see who care to... 80 oil...1100 gold...

as for deflation hudson nailed it in an ej interview in 2007.... 'deflation is a psychodrama... like an obsessional fear that some day gravity will stop working & we'll all float into the air. the fed's double entry bookkeeping will not stop working'... paraphrasing.

ST
02-24-10, 10:52 AM
We were told "deflation!" in 2001 and didn't buy it. They told us we were stupid. Did deflation happen? In 2007 they screamed "deflation!" Did deflation happen? Today they again warn "deflation!" As the joke goes, "Sometimes I don't think you're here for the hunting."

Yes, but FRED, what seems lost in the mix is that some of these analysts are looking at a completely different time frame than you. When you hear 'deflation' you seem to always equate that to 'long term deflationary spiral'.

Look, these guys are looking at data everyday and they are NOT talking about a ten year picture. When a data driven guy like Rosenberg is looking at what's going on (and spitting out his data and analysis every single day for free for all to see and scrutinize ) and he is talking about deflation - he is talking about moves like oil going from $147 to $30 in the short term, for instance.

Yes, maybe he doesn't understand the big picture process, but you should be open to the possibility that, despite the contradiction, he may understand the short term picture in bonds, equities & commodities more adequately than you guys, dues to decades of investment market experience.

jpatter666
02-24-10, 11:04 AM
Yes, but FRED, what seems lost in the mix is that some of these analysts are looking at a completely different time frame than you. When you hear 'deflation' you seem to always equate that to 'long term deflationary spiral'.

Look, these guys are looking at data everyday and they are NOT talking about a ten year picture. When a data driven guy like Rosenberg is looking at what's going on (and spitting out his data and analysis every single day for free for all to see and scrutinize ) and he is talking about deflation - he is talking about moves like oil going from $147 to $30 in the short term, for instance.

Yes, maybe he doesn't understand the big picture process, but you should be open to the possibility that, despite the contradiction, he may understand the short term picture in bonds, equities & commodities more adequately than you guys, dues to decades of investment market experience.

I agree -- and isn't this the essence of disinflation anyways?

We may not get a huge deflationary crash like 2008, but I can see smaller and smaller deflationary bounces coming down the line, counterbalanced by inflationary responses in certain areas. At the end of that, we hit the POOM in everything.

ST
02-24-10, 11:19 AM
I agree -- and isn't this the essence of disinflation anyways?

We may not get a huge deflationary crash like 2008, but I can see smaller and smaller deflationary bounces coming down the line, counterbalanced by inflationary responses in certain areas. At the end of that, we hit the POOM in everything.

disinflation - yeah I think so - we have to remember that some of these guys like Rosenberg moved into corporate bonds at the low, so in terms of asset valuation in a reflation they just may know what they are doing, even if they seem to buy into output gap theory; in the short term such a view might be correct - it is difficult to accept that all of these guys simply ignore the stagflationary period of the 70s - I don't think they all dismiss it.

I'm not so sure about the POOM in everything - I think at some point central banks understand the mechanics of stagflation. I think what is underestimated is that the Fed has learned from the 70s, despite Bernanke's predecessor.

What if reality strikes the markets and everything tumbles again and if the Fed can begin another re-inflation from another low point in commodity prices? and meanwhile the China bubble has popped? Maybe we start another reflation from copper at $0.70 because the Chinese story evaporates - maybe next time the Fed's attempts only take it up to $2 because they have learned that after a certain point stimulus doesn't work under a balance sheet recession and they bring on more problems than they solve.

I don't think the future is so clear and I think the iTulip view is highly dependent on central bank reaction and an assumption that they haven't learned anything from the past. If the helm of these banks was the same for the last forty years, perhaps, but just maybe at some point a leader emerges to explain that some real pain has to be taken in the short term and that gov't attempts will just make things worse.

EJ seems to think we avoid another extreme downdraft in commodity prices because his perception is that too many people expect it now - I think he is likely skewed by the company he keeps these days (smarter money managers). A true contrarian is only contrary 20% of the time and has to ride the trend for 80% of the time while others wake up to the story.

stanley2008
02-24-10, 10:19 PM
Ig

but the predicted inflation is already here... for all to see who care to... 80 oil...1100 gold...

as for deflation hudson nailed it in an ej interview in 2007.... 'deflation is a psychodrama... like an obsessional fear that some day gravity will stop working & we'll all float into the air. the fed's double entry bookkeeping will not stop working'... paraphrasing.

Why then does EJ suggest allocating some portion of ones' capital to fixed income securities?

ST
02-25-10, 08:34 AM
Why then does EJ suggest allocating some portion of ones' capital to fixed income securities?

Good question and if he is in short duration treasuries, why bother; there are better alternatives. If he is in the long duration treasuries, hasn't this been the performance of late? (120 -> 90 since Jan'09)

http://chart.finance.yahoo.com/c/2y/t/tlt

My take is that short term he is expecting a rally in long bonds as asset price deflation takes hold again in equity & housing markets.

jiimbergin
02-25-10, 08:43 AM
Good question and if he is in short duration treasuries, why bother; there are better alternatives. If he is in the long duration treasuries, hasn't this been the performance of late? (120 -> 90 since Jan'09)

http://chart.finance.yahoo.com/c/2y/t/tlt

My take is that short term he is expecting a rally in long bonds as asset price deflation takes hold again in equity & housing markets.

EJ went long last June so not much change since then. He mentioned then that there was a risk in doing so, but he was doing it for the increase in yield.

jim

jk
02-26-10, 12:05 PM
disinflation - yeah I think so - we have to remember that some of these guys like Rosenberg moved into corporate bonds at the low, so in terms of asset valuation in a reflation they just may know what they are doing, even if they seem to buy into output gap theory; in the short term such a view might be correct - it is difficult to accept that all of these guys simply ignore the stagflationary period of the 70s - I don't think they all dismiss it.

I'm not so sure about the POOM in everything - I think at some point central banks understand the mechanics of stagflation. I think what is underestimated is that the Fed has learned from the 70s, despite Bernanke's predecessor.

What if reality strikes the markets and everything tumbles again and if the Fed can begin another re-inflation from another low point in commodity prices? and meanwhile the China bubble has popped? Maybe we start another reflation from copper at $0.70 because the Chinese story evaporates - maybe next time the Fed's attempts only take it up to $2 because they have learned that after a certain point stimulus doesn't work under a balance sheet recession and they bring on more problems than they solve.

I don't think the future is so clear and I think the iTulip view is highly dependent on central bank reaction and an assumption that they haven't learned anything from the past. If the helm of these banks was the same for the last forty years, perhaps, but just maybe at some point a leader emerges to explain that some real pain has to be taken in the short term and that gov't attempts will just make things worse.

EJ seems to think we avoid another extreme downdraft in commodity prices because his perception is that too many people expect it now - I think he is likely skewed by the company he keeps these days (smarter money managers). A true contrarian is only contrary 20% of the time and has to ride the trend for 80% of the time while others wake up to the story.
my take is that itulip espouses "lazy" trading. very few, or very rare, changes in allocation. the ideal, in my mind [i don't speak for itulip] is the rip van trader marc faber sometimes talks about: he makes one trade a decade. in 1970 he told his broker to put it all in gold as soon as that was possible, and then he went on vacation. in 1980 he woke up long enough to say: move it all into japanese equities. in 1990 he switched to tech stocks in the u.s. in 2000 he switched to... faber's story ended there, but i would say gold and oil. the lazy trader can do quite well if the asset allocations are correct.

dummass
02-26-10, 06:06 PM
I don't think the future is so clear and I think the iTulip view is highly dependent on central bank reaction and an assumption that they haven't learned anything from the past. If the helm of these banks was the same for the last forty years, perhaps, but just maybe at some point a leader emerges to explain that some real pain has to be taken in the short term and that gov't attempts will just make things worse.

It's my feeling that EJ has studied history. Throughout history, certain patterns have emerged; it always seems to turned out the same.

Is this because bankers always make the same mistakes (as they would have us believe)? Or is this because bankers' actions are motivated by some other, unstated, objective that you fail to understand?

Sharky
02-26-10, 07:43 PM
We were told "deflation!" in 2001 and didn't buy it. They told us we were stupid. Did deflation happen? In 2007 they screamed "deflation!" Did deflation happen? Today they again warn "deflation!" As the joke goes, "Sometimes I don't think you're here for the hunting." :D

We didn't get a deflationary spiral, but we did get:

1. A decline of 40%+ in the stock market
2. A decline of 20%+ in the housing market
3. A drop of nearly 80% in the price of oil from its peak
4. Similarly dramatic declines in other commodity prices
5. Short-term Treasuries near 0%
6. The Baltic Dry Index dropped by 90% or so

Kinda sounds deflationary to me--at least on the asset side.

The destruction of asset values still has not been fully compensated for on the money creation side. We've lost at least $12 trillion in asset values, with only roughly $2T in new money. Now we have huge drops in commercial real estate, plus unrecognized losses from the collapses in Dubai and Greece, possibly to followed soon by the rest of the PIIGS--and I suspect China may not be far behind. M3 growth is negative y/o/y. The pressure on asset prices at the moment still feels deflationary to me. Am I missing something?

I'm not saying that we won't have Poom eventually, but all the indicators seem to say that it's a ways off yet.

Also, market expectations appear to be inflationary, with regular, fearful-sounding references to how much money the Fed is creating. Doesn't that make deflation the contrarian view at the moment?

metalman
02-26-10, 09:32 PM
We didn't get a deflationary spiral, but we did get:

1. A decline of 40%+ in the stock market

asset price deflation... as predicted.


2. A decline of 20%+ in the housing market

asset price deflation... as predicted.


3. A drop of nearly 80% in the price of oil from its peak

then recovered to $80 not $20 as in 2001... disinflation... as predicted.


4. Similarly dramatic declines in other commodity prices

with quick recovery to new highs... gold... silver... as predicted.


5. Short-term Treasuries near 0%

as predicted.


6. The Baltic Dry Index dropped by 90% or so

huh... still getting sneakers & tvs here.



Kinda sounds deflationary to me--at least on the asset side.

$1100 gold, $80 oil, $16 silver sounds deflationary to you?


The destruction of asset values still has not been fully compensated for on the money creation side. We've lost at least $12 trillion in asset values, with only roughly $2T in new money. Now we have huge drops in commercial real estate, plus unrecognized losses from the collapses in Dubai and Greece, possibly to followed soon by the rest of the PIIGS--and I suspect China may not be far behind. M3 growth is negative y/o/y. The pressure on asset prices at the moment still feels deflationary to me. Am I missing something?

yeh, the gov't reaction to these events destroys the value of the underlying unit... the currency.


I'm not saying that we won't have Poom eventually, but all the indicators seem to say that it's a ways off yet.

don't hold your breath for $750 gold again. that's gone. $1000 gold is gone.


Also, market expectations appear to be inflationary, with regular, fearful-sounding references to how much money the Fed is creating. Doesn't that make deflation the contrarian view at the moment?

contrarianism for contrarian's sake is a fool's game. what's the long term trend? since 2001... peak cheap oil & crashing bubbles. weak gov't = weak economy = weak currency.

cindykimlisa
02-26-10, 09:52 PM
asset price deflation... as predicted.



asset price deflation... as predicted.



then recovered to $80 not $20 as in 2001... disinflation... as predicted.



with quick recovery to new highs... gold... silver... as predicted.



as predicted.



huh... still getting sneakers & tvs here.



$1100 gold, $80 oil, $16 silver sounds deflationary to you?



yeh, the gov't reaction to these events destroys the value of the underlying unit... the currency.


don't hold your breath for $750 gold again. that's gone. $1000 gold is gone.



contrarianism for contrarian's sake is a fool's game. what's the long term trend? since 2001... peak cheap oil & crashing bubbles. weak gov't = weak economy = weak currency.


The problem is metalman you really don't get it. Long term you and ej predict everything to happen so you are always right and always wrong.

Its bullshit. Everyting is all going to happen again maybe sooner maybe later I already told you that and some of it has already happened. Your horizon seems to be history.

Amazing

Cindy

metalman
02-26-10, 10:00 PM
Everyting is all going to happen again maybe sooner maybe later I already told you that and some of it has already happened.

everything is going to happen again. that's got to be the most hilarious theory i've ever read.

we'll never get another chance to sell tech at nasdaq 5000 & ej said so in 2000.

we'll never get another chance at $260 gold & ej said so in 2001.

we'll never get another chance to get out of housing at mid 2005 levels & ej said so then.

we'll never get another chance to short the dow at 13K & ej said so in 2007.

etc... etc... etc..

if you're too lazy to read the old articles... blah. that's your problem.

cindykimlisa
02-26-10, 10:37 PM
everything is going to happen again. that's got to be the most hilarious theory i've ever read.

we'll never get another chance to sell tech at nasdaq 5000 & ej said so in 2000.

we'll never get another chance at $260 gold & ej said so in 2001.

we'll never get another chance to get out of housing at mid 2005 levels & ej said so then.

we'll never get another chance to short the dow at 13K & ej said so in 2007.

etc... etc... etc..

if you're too lazy to read the old articles... blah. that's your problem.

Never say never

It will happen again - time and space are relative and on that basis it is actually happening now and tommorrow and yesterday somewhere.

If the above sounds like jibberish it is because it is much like what you often sound like.

Cheers

Cindy

metalman
02-26-10, 10:40 PM
Never say never

It will happen again - time and space are relative and on that basis it is actually happening now and tommorrow and yesterday somewhere.

If the above sounds like jibberish it is because it is much like what you often sound like.

Cheers

Cindy

actually... i always try to be clear & give backup details & links & so forth. you?

will happen again? 'in the long run, we're all dead'.

Sharky
02-26-10, 11:27 PM
asset price deflation... as predicted.


Right. The key word there is deflation. As I said.



then recovered to $80 not $20 as in 2001... disinflation... as predicted.


$20 would be the spiral. But as you just admitted, it was deflationary for a time. So the deflationists were right, at least to that extent; they just didn't catch the reversal.


with quick recovery to new highs... gold... silver... as predicted.

$1100 gold, $80 oil, $16 silver sounds deflationary to you?

I don't mean now. I mean during the deflationary (as you said yourself) price declines I mentioned. We are clearly back in an inflationary period. But will it continue, or will it slide back into another deflationary period as the reality of how bad things really are begins to sink in with the public?


yeh, the gov't reaction to these events destroys the value of the underlying unit... the currency.

Eventually. The open question to me is whether that process has started yet to a degree that's strong enough to overcome the still ongoing deflationary pressures. I don't think the answer is clear-cut by any means.


don't hold your breath for $750 gold again. that's gone. $1000 gold is gone.

Maybe, but I'm not as certain about it as you seem to be.


contrarianism for contrarian's sake is a fool's game. what's the long term trend? since 2001... peak cheap oil & crashing bubbles. weak gov't = weak economy = weak currency.

Couldn't you also say that weak economy = weak demand = lower asset prices. Or do you believe that the P/E ratios on the S&P are somehow sustainable?

Also, debt defaults = money destruction = stronger currency. The USD isn't particularly weak at the moment, in spite of ZIRP, TARP, etc. Why is that?

metalman
02-27-10, 12:45 AM
Right. The key word there is deflation. As I said.

for the 293th time, you have to distinguish between assets & wages/commodities... to fail to do so it to completely misunderstand how the economy works. you'll keep getting it wrong.


$20 would be the spiral. But as you just admitted, it was deflationary for a time. So the deflationists were right, at least to that extent; they just didn't catch the reversal.

the deflationists predicted a spiral with prices falling & falling for yrs & yrs ala 1930s.

didn't happen.

incorrect. wrong.

ej predicted a short period of deflation called 'disinflation' followed by renewed inflation. that is exactly what happened.

correct. right.

see the difference?


I don't mean now. I mean during the deflationary (as you said yourself) price declines I mentioned.

for 2 months... not 2 yrs or 4 yrs. disinflation... as predicted.


We are clearly back in an inflationary period. But will it continue, or will it slide back into another deflationary period as the reality of how bad things really are begins to sink in with the public?

will gravity stop working? will we all float into the air? maybe. i'm not betting on it.


Eventually. The open question to me is whether that process has started yet to a degree that's strong enough to overcome the still ongoing deflationary pressures. I don't think the answer is clear-cut by any means. Maybe, but I'm not as certain about it as you seem to be.

deflation = rising purchasing power of $$$ vs commodities/wages. you betting on that with usa budget deficits @ 13% of gdp? good luck.


Couldn't you also say that weak economy = weak demand = lower asset prices. Or do you believe that the P/E ratios on the S&P are somehow sustainable?

i could say that but first i'd have to have the front lobes of by brain removed. asset price inflations happen when too much credit chases not enough assets. artificial demand from temporary purchasing power. not happening today.

then add to this the fact that there's no more cheap oil, so even if primary (consumer) demand returns, inflation returns with it.


Also, debt defaults = money destruction = stronger currency. The USD isn't particularly weak at the moment, in spite of ZIRP, TARP, etc. Why is that?

wat?

if ducks = money
& rabbits = money
do ducks = rabbits?

gosh, where are you getting this stuff from? mish/denniger? when i read ash or grg or a dozen others here i feel smarter for it. when i read those guys it's like rats eating holes in my brain.


debt defaults = money destruction?

money is never destroyed.


money destruction = stronger currency?

demand for currency > quantity of currency = stronger currency

cindykimlisa
02-27-10, 12:48 PM
the deflationists predicted a spiral with prices falling & falling for yrs & yrs ala 1930s.

didn't happen.

incorrect. wrong.

ej predicted a short period of deflation called 'disinflation' followed by renewed inflation. that is exactly what happened.

correct. right.

see the difference?


First: we are not "the deflationists."

Second you say:
"ej predicted a short period of deflation called 'disinflation' followed by renewed inflation. that is exactly what happened."

That is NOT what happened to assets and wages and commodities macroeconomically. Maybe it happened somewhere near you. Housing is still going down, Commercial Real estate still going down, wages to the masses going down, hours per week going down, Oil down and stayed down,Unemployemnt up and stayed up, Tech prices dropping every day,

Do you live on Mars? Because you seem out of this world sometimes!

Cindy

Sharky
02-27-10, 04:28 PM
for the 293th time, you have to distinguish between assets & wages/commodities... to fail to do so it to completely misunderstand how the economy works. you'll keep getting it wrong.

I have been talking about asset deflation; sorry if that wasn't clear.

What I responded to in the earlier post was what appeared to be a claim that all of the predictions of deflation were wrong (I'm not talking about someone specific like Mish; I'm talking about broad market expectations). The truth is that they were partly right. There was deflation (and still is in some sectors); we just didn't get the death spiral.


ej predicted a short period of deflation called 'disinflation' followed by renewed inflation. that is exactly what happened.

I thought "disinflation" was inflation that was happening at a declining rate, not "a short period of deflation."


asset price inflations happen when too much credit chases not enough assets. artificial demand from temporary purchasing power. not happening today.

OK, now I'm confused. I thought you said earlier that you thought asset price inflation was still happening. So are you saying that we're still in an asset price deflationary period?


money is never destroyed.

Money is created whenever a bank creates a new loan. Money is destroyed when the loan is paid off. Money is also destroyed if the borrower defaults on the loan; when the bank (eventually) writes off the loan, the loss is taken against their capital, which destroys money (unless it gets replaced by TARP or the like).

Current savings rates are about 6% in the US. Much of those "savings" are going to pay off loans, which destroys money.

Money (in the form of bank reserves) is also regularly created and destroyed by the Fed, via the FOMC, as they buy and sell bonds in the open market.


demand for currency > quantity of currency = stronger currency

Right, so if demand stays the same and the quantity goes down, then the currency gets stronger. The relative rates of change can also come into play: if the quantity of money doesn't increase as fast as demand does (or if demand goes down), then the currency gets stronger. The increasing savings rates are an indicator of increasing demand. Another factor on the supply side is that the rate of new loan creation is still low.

dummass
02-27-10, 06:22 PM
Money is destroyed when the loan is paid off. Money is also destroyed if the borrower defaults on the loan; when the bank (eventually) writes off the loan, the loss is taken against their capital, which destroys money (unless it gets replaced by TARP or the like).

I only half agree with your two examples:

1) When a loan is paid off--the money has been received; it is available to be loaned again or to be used for other purposes. The money still exists.

2) When a borrower defaults--money is destroyed.

ThePythonicCow
02-27-10, 08:30 PM
2) When a borrower defaults--money is destroyed.I don't think so. When a borrower defaults, they get to keep the money that would have been paid. Granted, perhaps the borrower didn't have the money in hand to pay, but still by not paying, they are less bankrupt than they otherwise would have been.

Just ask the IRS. My (inexpert, non-professional) understanding is that they will tax you on the defaulted amount as if it were income.

Sharky
02-28-10, 12:40 AM
I only half agree with your two examples:

1) When a loan is paid off--the money has been received; it is available to be loaned again or to be used for other purposes. The money still exists.

2) When a borrower defaults--money is destroyed.

When you take out a loan, here's how it works:

1. Let's say that a bank's first and only deposit is $1000 cash. That cash becomes "reserves." 90% of that amount becomes "excess reserves." Banks can only create new loans when they have excess reserves available.

2. A potential borrower comes to the bank, and puts up some form of collateral, such the deed to their house or car. The maximum amount they can borrow is equal to the bank's excess reserves.

3. The collateral is used to create a note, which is a promise to back the loan within a certain time at a certain interest. When the borrower signs the note, they are effectively signing over ownership of the collateral to the bank until the note is repaid, while retaining use privileges in the mean time.

4. When the loan is funded, the proceeds are credited to the borrower's account. However, a very important point here: the loan is not funded from the bank's reserves. It is funded by creating new money, just for that purpose. As with all accounting transactions, there are two sides to this one. The other side in this case is the creation of an asset with the same value as the money created (which is a liability). That asset is the note.

5. The borrower makes payments on the loan. Interest goes to the bank as income, which they can then use to cover their expenses or to pay out to shareholders, as any company would. Principal goes to pay down the note. Banks don't just keep the returned principle around and re-lend it at a later time. The money is destroyed when it's paid back, and then re-created later if/when needed for a new loan.

6. If the borrower defaults, then when the loss is recognized, the collateral is sold. If the collateral is worth less than the remaining value of the note, the difference is written off against bank earnings. In effect, the money representing bank earnings is destroyed. This happens because although banks can create money, they can't create their own earnings, and they are required to accept the consequences of making loans that don't get paid back (well, at least that's the theory, until gov gets involved via the FDIC, the Fed, TARP, etc).

Sharky
02-28-10, 02:13 AM
I don't think so. When a borrower defaults, they get to keep the money that would have been paid. Granted, perhaps the borrower didn't have the money in hand to pay, but still by not paying, they are less bankrupt than they otherwise would have been.

Just ask the IRS. My (inexpert, non-professional) understanding is that they will tax you on the defaulted amount as if it were income.

Yes, if you default on a loan, the money you borrowed stays in circulation, and it becomes income to you, and you are taxed on it. But that's only one side of the equation.

From the bank's perspective, they created a bunch of money that they won't get back. Banks don't create money risk-free; they're not allowed to just walk away from a bad loan. If borrowers don't pay it back, then the loan gets written off against the bank's income (or capital); to the extent that the sale of the loan's collateral doesn't cover the loan's balance, it becomes a loss to the bank.

Instead of the borrower sending money as principle which then decreases the value of the note and gets destroyed, the bank does the same thing: they effectively pay off the loan on your behalf (assuming they still hold it, of course, and haven't sold it to some other bank).

Yes, banks can and do lose money. How else could it work? No other customers have their bank balance changed when you default. If the asset's value (the note) drops to zero, what other source is there for the other side of the accounting transaction, other than the bank itself (eventually the government will become the source, but only when the bank loses so much that it's close to failure)?

dummass
02-28-10, 02:00 PM
here's how it works:

Banks don't just keep the returned principle around and re-lend it at a later time. The money is destroyed when it's paid back, and then re-created later if/when needed for a new loan.



Go on... please continue. How do the banks destroy the money?

Since you claim to understand the process, so completely, perhaps you can enlighten the rest of us. From what you have said so far, it sounds like magic.

dummass
02-28-10, 02:29 PM
I don't think so. When a borrower defaults, they get to keep the money that would have been paid. Granted, perhaps the borrower didn't have the money in hand to pay, but still by not paying, they are less bankrupt than they otherwise would have been.

Just ask the IRS. My (inexpert, non-professional) understanding is that they will tax you on the defaulted amount as if it were income.

I'm coming around, TPC. You may be right. Once the money is created, it is never destroyed.

For example: when a loan is made, the bank creates money and trades it for the car, house or some form of collateral. The seller receives the new money in full and the buyer has a debt. The money, however, has already been "set free" in the economy; it can be used for other purposes, without restriction.

The Jeanie won't go back in the bottle.

If the bank receives any portion of the money back, through principal or interest payments, they will merely recirculate the funds like anyone ells who receives payments for goods or services.

Sharky
02-28-10, 03:30 PM
Go on... please continue. How do the banks destroy the money?

Since you claim to understand the process, so completely, perhaps you can enlighten the rest of us. From what you have said so far, it sounds like magic.

The process of money creation is described in Modern Money Mechanics, published by the Federal Reserve Bank of Chicago (Google it for a copy).

As the document explains, money is created through a simple accounting entry: an amount is added to the borrower's account balance.

Money destruction in the event of default works similarly. Like when the loan is paid off, the note is destroyed. The difference is that instead of the offsetting accounting entry being applied against the borrower's account balance, it's applied against bank capital.

This is the reason why all of the foreclosures and other defaults put such a strain on the banking system: basically, all of their capital would have been destroyed if the losses were fully recognized.

ThePythonicCow
02-28-10, 05:19 PM
I'm coming around, TPC. You may be right. Once the money is created, it is never destroyed. It's wealth that gets created and destroyed. Money is just (1) the measure of wealth and (2) a transient liquid means for conveying and converting wealth. We don't worry about running out of "degrees" on our thermometers when it gets cold in the winter. We worry only a little bit, as it's a problem easily enough solved, about how to convey the heat from the burning wood or oil in our stoves to our bodies. We would worry a lot if we were about to run out of that wood or oil to burn. Money is the means of measure (the degrees on the thermometer) and a transient, liquid form of wealth.

Don't focus on the money; focus on the wealth and the integrity.

The destruction of wealth does not occur so much in present value transactions as it occurs in the discounting of future value.

In times of "sound money", the present value (asset prices) of debt paper, stock equity, real estate, property or the tools and factories and mines of production is closely tied to the future income streams to be expected from those assets.

In times of financial folly and excess, these asset prices balloon all out of proportion to their future return. When a bubble collapse forces me to recognize great losses in the "value" of my home or stock, I am being forced to recognize the fraudulent asset pricing of the bubble.

Money comes and goes as is needed to represent the immediately liquid proportion of our wealth. Most of our wealth is not held as money, and the volume of money is no more of interest to our well being than the volume of oil in an engine determines its power. So long as the amount of oil in the engine is within the range for which the oil pump and lubrication system were designed, then other matters determine how much power the engine produces.

The problem of money is that people mistake it for the wealth it measures and for which it serves as a temporary, liquid store.

Our economic problems begin when our wealth is too much fluff (flat screen TVs and faux-granite counter tops and degrees in ethnic studies) and too little the basis for continuing production and invention. Our financial problems are marked by a grievous disconnect between present day asset prices, as carried on our books, and the future income or production value of those assets. Our cultures problems are due to a growing dishonesty as the few percent of the population that are inherently sociopathic liars gain an increasing proportion of the power.

dummass
02-28-10, 06:20 PM
The process of money creation is described in Modern Money Mechanics, published by the Federal Reserve Bank of Chicago (Google it for a copy).

As the document explains, money is created through a simple accounting entry: an amount is added to the borrower's account balance.

Money destruction in the event of default works similarly. Like when the loan is paid off, the note is destroyed. The difference is that instead of the offsetting accounting entry being applied against the borrower's account balance, it's applied against bank capital.

This is the reason why all of the foreclosures and other defaults put such a strain on the banking system: basically, all of their capital would have been destroyed if the losses were fully recognized.

Clever tactic Sharky, try to send me off to read a 50 page document that doesn't answer my question.

Perhaps you could point us to the page and paragraph that describes how banks destroy money when a loan is payed off.

It would appear that you are confusing bank reserves and money.

metalman
02-28-10, 06:32 PM
the deflationists predicted a spiral with prices falling & falling for yrs & yrs ala 1930s.

didn't happen.

incorrect. wrong.

ej predicted a short period of deflation called 'disinflation' followed by renewed inflation. that is exactly what happened.

correct. right.

see the difference?



First: we are not "the deflationists."

what is your position then?


Second you say:
"ej predicted a short period of deflation called 'disinflation' followed by renewed inflation. that is exactly what happened." yes it is.


That is NOT what happened to assets and wages and commodities macroeconomically. yes it is.


Maybe it happened somewhere near you. yes it has, globally.


Housing is still going down, Commercial Real estate still going down, wages to the masses going down, hours per week going down, Oil down and stayed down,Unemployemnt up and stayed up, Tech prices dropping every day,again, for the 27384643849484th time, asset price deflation is not commodity/wage deflation. monetary policy is separate. money/credit inflating assets vs commodities/wages is separate. one can spill over into the other, and did briefly... as predicted here.


Do you live on Mars? Because you seem out of this world sometimes!

Cindyguess i just have to keep repeating the facts until they sink in.

Sharky
02-28-10, 08:17 PM
Perhaps you could point us to the page and paragraph that describes how banks destroy money when a loan is payed off.

There are several versions of the document. Use this one:

http://upload.wikimedia.org/wikipedia/commons/4/4a/Modern_Money_Mechanics.pdf

Start with the section called "Who Creates Money?" on Page 3.


The actual process of money creation takes place primarily in banks. As noted earlier, checkable liabilities of banks are money. These liabilities are customers' accounts. They increase when customers deposit currency and checks and when the proceeds of loans made by the banks are credited to borrowers' accounts.On page 6:


What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system.Page 7, step 3 shows the accounting transaction that creates new money: Borrower deposits (liability) are increased by $9000, while Loans (assets) also increase by $9000:


Expansion takes place only if the banks that hold these excess reserves (Stage 1 banks) increase their loans or investments. Loans are made by crediting the borrower's deposit account, i.e., by creating additional deposit money.The contraction process isn't explained in as much detail, because it's simply the reverse of expansion. On Page 12:


As in the case of deposit expansion, contraction of bank deposits may take place as a result of either sales of securities or reductions of loans. While some adjustments of both kinds undoubtedly would be made, the initial impact probably would be reflected in sales of government securities. Most types of outstanding loans cannot be called for payment prior to their due dates. But the bank may cease to make new loans or refuse to renew outstanding ones to replace those currently maturing. Thus, deposits built up by borrowers for the purpose of loan retirement would be extinguished as loans were repaid.

dummass
02-28-10, 08:49 PM
There are several versions of the document. Use this one:

http://upload.wikimedia.org/wikipedia/commons/4/4a/Modern_Money_Mechanics.pdf

Start with the section called "Who Creates Money?" on Page 3.

On page 6:

Page 7, step 3 shows the accounting transaction that creates new money: Borrower deposits (liability) are increased by $9000, while Loans (assets) also increase by $9000:

The contraction process isn't explained in as much detail, because it's simply the reverse of expansion. On Page 12:

None of this proves your point. The reason why "the contraction process isn't explained in as much detail," as you pointed out, is because banks don't destroy money through loan payoff or default.

Not to say that banks can't destroy money, because they can and they do. However, they don't do it by the means that you suggest.

When banks use money to buy Treasuries and then park those Treasuries at the Federal Reserve Bank, the money is no longer available in the economy. They could also burn it, but that's less likely. :D

jiimbergin
02-28-10, 09:03 PM
None of this proves your point. The reason why "the contraction process isn't explained in as much detail," as you pointed out, is because banks don't destroy money through loan payoff or default.

Not to say that banks can't destroy money, because they can and they do. However, they don't do it by the means that you suggest.

When banks use money to buy Treasuries and then park those Treasuries at the Federal Reserve Bank, the money is no longer available in the economy. They could also burn it, but that's less likely. :D

Here is a good expaination of how a default does indeed destroy money. The first part is a quote from another site that agees with you, however the rest of the post shows clearly how money is indeed destroyed by defaults.


http://beyondtheblueeventhorizon.blogspot.com/2007/03/debt-defaults-and-money-supply.html


Thursday, March 29, 2007

Debt Defaults and the Money Supply (http://beyondtheblueeventhorizon.blogspot.com/2007/03/debt-defaults-and-money-supply.html)


Steve Saville of www.speculative-investor.com (http://www.speculative-investor.com/) recently published an article to which he appended the following note:

"Many people believe that debt defaults cause the supply of money to shrink, but this is not so. A debt default will probably reduce the wealth of the person/company making the loan, but if the loan originally resulted in new money being created -- for example, a loan made by a commercial bank to finance the purchase of a home -- then that money will have been spent by the debtor and will remain within the economy following the loan default. Of course, if the customers of a lender default on their loans then the ability and/or desire of that lender to make additional loans may be hampered. It is therefore possible for debt defaults to bring about a reduction in the future rate of money supply growth, but debt defaults do not directly affect the existing supply of money."

(Emphasis mine).

This is a meme that I have come across on many message boards, but this is the first time I have seen it offered by a (self-appointed) analyst. The question is: "is it true?"

Let's follow through the logic.

1) A bank is established with, say $1m of capital.
2) It acquires $9m of deposits for a total of $10m of equity and liabilities.
3) The bank makes $10m of loans, say, 100 loans of $100k each.
4) The borrowers spend the money in the economy.
5) One of the $100k borrowers defaults, without paying any principle or interest.

So the money made it out of the bank and into the economy where it is trapped and can never be destroyed (according to Saville) right? Not so fast.

Let's liquidate the bank and see what we have. We sell off the loan portfolio at book for $9.9m. We use $9m to pay off our depositors. We use the remaining $900k to pay off the equity holders - $100k less than they provided to capitalize the bank.

It's clear that the $100k loan default has resulted in the destruction of $100k originally used to capitalize the bank. That's a wash, a one for one destruction of the money created through the loan.

My mental model of credit created cash is like a matter ($) - antimatter (debt) pair. They can exist seperately for a time (dictated by the terms of the loan), but ultimately the anti-matter will seek out an exact equal amount of matter to destroy. The money originally loaned into existence is either paid back or the capital backing the loan is consumed.

Naturally we can make this model more complete: What about the interest, what if we can't sell the loans at face value, what if the defaults exceed the banks capital, what if the FDIC bails out the depositers, etc, etc. It's the same in every case: someone's capital gets destroyed in equal amount to the default. If your analysis seems to leave money trapped in the economy you are not thinking hard enough (it's like the first law of thermodynamics).

I like Steve Saville's work as a well argued counterpoint to hardcore deflationists, but he is wrong on this point, defaults are deflationary.

dummass
02-28-10, 09:32 PM
Here is a good expaination of how a default does indeed destroy money. The first part is a quote from another site that agees with you, however the rest of the post shows clearly how money is indeed destroyed by defaults.


http://beyondtheblueeventhorizon.blogspot.com/2007/03/debt-defaults-and-money-supply.html


Thursday, March 29, 2007

Debt Defaults and the Money Supply (http://beyondtheblueeventhorizon.blogspot.com/2007/03/debt-defaults-and-money-supply.html)


Steve Saville of www.speculative-investor.com (http://www.speculative-investor.com/) recently published an article to which he appended the following note:

"Many people believe that debt defaults cause the supply of money to shrink, but this is not so. A debt default will probably reduce the wealth of the person/company making the loan, but if the loan originally resulted in new money being created -- for example, a loan made by a commercial bank to finance the purchase of a home -- then that money will have been spent by the debtor and will remain within the economy following the loan default. Of course, if the customers of a lender default on their loans then the ability and/or desire of that lender to make additional loans may be hampered. It is therefore possible for debt defaults to bring about a reduction in the future rate of money supply growth, but debt defaults do not directly affect the existing supply of money."

(Emphasis mine).

This is a meme that I have come across on many message boards, but this is the first time I have seen it offered by a (self-appointed) analyst. The question is: "is it true?"

Let's follow through the logic.

1) A bank is established with, say $1m of capital.
2) It acquires $9m of deposits for a total of $10m of equity and liabilities.
3) The bank makes $10m of loans, say, 100 loans of $100k each.
4) The borrowers spend the money in the economy.
5) One of the $100k borrowers defaults, without paying any principle or interest.

So the money made it out of the bank and into the economy where it is trapped and can never be destroyed (according to Saville) right? Not so fast.

Let's liquidate the bank and see what we have. We sell off the loan portfolio at book for $9.9m. We use $9m to pay off our depositors. We use the remaining $900k to pay off the equity holders - $100k less than they provided to capitalize the bank.

It's clear that the $100k loan default has resulted in the destruction of $100k originally used to capitalize the bank. That's a wash, a one for one destruction of the money created through the loan.

My mental model of credit created cash is like a matter ($) - antimatter (debt) pair. They can exist seperately for a time (dictated by the terms of the loan), but ultimately the anti-matter will seek out an exact equal amount of matter to destroy. The money originally loaned into existence is either paid back or the capital backing the loan is consumed.

Naturally we can make this model more complete: What about the interest, what if we can't sell the loans at face value, what if the defaults exceed the banks capital, what if the FDIC bails out the depositers, etc, etc. It's the same in every case: someone's capital gets destroyed in equal amount to the default. If your analysis seems to leave money trapped in the economy you are not thinking hard enough (it's like the first law of thermodynamics).

I like Steve Saville's work as a well argued counterpoint to hardcore deflationists, but he is wrong on this point, defaults are deflationary.

Thank you, Jiimbergin, your example proves my point.

1) To start with, the bank in your example never created any money. The funds were all donated by depositors ($9M) and paid in capital ($1M). That money already existed before it was lent by the bank.

2) If the bank didn't create any money, how can you blame them for destroying it!

3) Sure, the bank lost 100K, but that money wasn't destroyed. The guy who borrowed the money and defaulted, received the benefit of that money. He used that money for some purpose. If he bought something with that money, the seller would now have the money.

4) This example is rather poor in that the bank would, most likely, have a claim against assets, for which they may well recover their $100K.

Sharky
03-01-10, 12:21 AM
None of this proves your point. The reason why "the contraction process isn't explained in as much detail," as you pointed out, is because banks don't destroy money through loan payoff or default.

Sigh. You can lead a horse to water, etc, etc.

For anyone else who cares: "extinguising deposits" as in the quoted section, means that the money is destroyed, of course.


When banks use money to buy Treasuries and then park those Treasuries at the Federal Reserve Bank, the money is no longer available in the economy. They could also burn it, but that's less likely.

Buying or selling Treasuries in the private market doesn't create or destroy money. If a bank buys Treasuries, they are buying them from some individual or company. When that other entity receives the proceeds from the transaction, they will be deposited into another bank. It's only when the Fed buys or sells Treasuries that the money supply is affected.

Oh, and money is never created by printing. Paper money (the only kind that be burned) only enters circulation in exchange for bank reserves, which are entirely digital.

Jay
03-01-10, 01:01 AM
The mechanism for inflation occurs when the bank is hit with multiple defaults, ends up with a huge hole on its balance sheet, and is then bailed out by the tax payer with freshly printed money (actually electrons in the form of bank reserves), which are then loaned back into the economy. The last part, new credit creation, hasn't really happened yet due to the Fed paying interest on reserves among other things. The inflation created is a multiple step process; the Fed needs to give the banks electronic reserves that are freshly brought into existence and then that "money" needs to hit the public. If the Fed doesn't replace the reserves, you get deflation through the eventual discovery of a balance sheet problem. The banks try and make themselves whole in the meantime through other means.

Sharky is 100% correct about how money is extinguished. Without the Fed creating new electronic money to fill a balance sheet hole, defaults are a zero sum game. The game the banks play is to hide the losses from the public for as long as possible, but they are there.

Sharky
03-01-10, 02:03 AM
Sharky is 100% correct about how money is extinguished. Without the Fed creating new electronic money to fill a balance sheet hole, defaults are a zero sum game. The game the banks play is to hide the losses from the public for as long as possible, but they are there.

Thanks for the support.

Although the Fed can create new money, it can only do so using debt-based mechanisms, usually by purchasing Treasuries through the FOMC (they create new money and use it to purchase Treasuries, which are then held on the books of the Fed). In particular, the Fed can't directly create bank capital. Banks can take loans from the Discount Window, but those are loans, so they live on both the asset and the liability side of a bank's balance sheet. In addition, loans from the Discount Window are only authorized against AAA-rated assets, and they are generally intended to be fairly short-term.

One way the Fed can help improve a bank's balance sheet is to improve their earnings by allowing them to borrow at a low interest rate, while lending at a much higher rate. Larger margins will increase earnings, thereby helping to replenish the loss of assets from their balance sheets.

New capital can only be created by the Treasury--which is why we ended up with the TARP program, where the Treasury purchased "troubled" (worthless) assets from banks, thereby directly filling balance sheet holes.

ThePythonicCow
03-01-10, 04:57 AM
defaults are a zero sum gamePerhaps this can better be understood not by asking whether defaults destroy money, but rather by considering defaults to be the result of asset price collapse. Lots of defaults are a result, not a cause, of the primary event, that being a bubble collapse. The mortgage based bubble assumed that real estate would always increase its value. That assumption (surprise, surprise!) was false.

Also, indirectly, a sufficient volume of such defaults, and the asset bubble collapse itself, will both decrease the money supply because they both weaken the balance sheets of banks, reducing future bank lending, thereby reducing future creation of more debt and money.

dummass
03-01-10, 05:20 AM
Buying or selling Treasuries in the private market doesn't create or destroy money. If a bank buys Treasuries, they are buying them from some individual or company. When that other entity receives the proceeds from the transaction, they will be deposited into another bank. It's only when the Fed buys or sells Treasuries that the money supply is affected.

Oh, and money is never created by printing. Paper money (the only kind that be burned) only enters circulation in exchange for bank reserves, which are entirely digital.


I didn't say banks should buy Treasuries on the open market, don't put words in my mouth. Banks would need to buy Treasuries from the Fed, not the open market. In fact, banks could buy anything on the Fed's balance sheet, including mortgage backed securities. I should have been more specific.

Insofar as paper money is concerned, what is your point? Are you now saying that burning money doesn't destroy it?

dummass
03-01-10, 05:54 AM
Sharky is 100% correct about how money is extinguished. Without the Fed creating new electronic money to fill a balance sheet hole, defaults are a zero sum game. The game the banks play is to hide the losses from the public for as long as possible, but they are there.

Jay, Sharky's claim is that Money is destroyed when loans are properly payed off, as well as defaulted on. Defaults intuitively make sense and initially, I granted his assertion. I've recently learned to question things that I have previously taken as fact; things are not always what they appear.

Sharky has not shown any proof for his claim and until he or someone ells can, I will remain unconvinced.

FRED
03-01-10, 04:59 PM
The mechanism for inflation occurs when the bank is hit with multiple defaults, ends up with a huge hole on its balance sheet, and is then bailed out by the tax payer with freshly printed money (actually electrons in the form of bank reserves), which are then loaned back into the economy. The last part, new credit creation, hasn't really happened yet due to the Fed paying interest on reserves among other things. The inflation created is a multiple step process; the Fed needs to give the banks electronic reserves that are freshly brought into existence and then that "money" needs to hit the public. If the Fed doesn't replace the reserves, you get deflation through the eventual discovery of a balance sheet problem. The banks try and make themselves whole in the meantime through other means.

Sharky is 100% correct about how money is extinguished. Without the Fed creating new electronic money to fill a balance sheet hole, defaults are a zero sum game. The game the banks play is to hide the losses from the public for as long as possible, but they are there.

EJ is writing a slew of Positions on Topics essays that we can all refer to in order to settle these disputes.

In one we created this chart of the Fed's balance sheet before and after the financial crisis. Recall that before the crisis we said the Fed was going to use the magic of double entry bookkeeping to rescue the banks. Well, here's what happened.


http://www.itulip.com/images2/FedBalanceSheetBeforeAfter.gif


The banks' bad assets became both the Fed's liability and its assets. The asset-backed securities and agency debt became deposits on the Fed's account. Not a penny was printed, and assets minus liabilities remains nearly the same. Neat, eh?

In a Positions on Topics on money creation, he explains that money is not destroyed via defaults. Money is only removed from the flow of money in the system when a loan is repaid.
Think of the money supply as a river of money that money flows in to and out of resulting from thousands of transactions conducted through thousands of pipes.

The Input pipes are the pipes that carry the money from a lender, money that is created when money is lent into existence and added to the river of money. The Output pipes carry money back out of the river to a lender as a loan is repaid. The level of the river of money, the total money supply, is determined by the relative rate of creation of new money, money added to the river via loans, versus the rate of old money removed from the river via loan repayment.

The part that trips up most people is this: it's not the same money, that is, the money repaid is not the same as the money that was created. Once the money is lent into existence and enters the river it spreads throughout the economy. There is no trail of bread crumbs that ties the dollars of the original loan back to the original lender. The new money created by a loan leaves the borrower's bank account as it is spent. There it moves to another person's account and is then re-spent. And on and on it goes, down the river, spreading and dissipating into the great flow. Throw a glass of water into a river, then try to go get it back. Good luck!

When a debt is repaid, an amount of money equal to the amount of money created money, plus interest, is withdrawn from the river of money. But loans are rarely repaid at once, but rather as a series of payments.

If the river of money flows at 1 billion dollars per hour, then a payment of $2,000 on a $100,000 loan equals a reduction of 1 millionth in the total flow. If at the same time a new loan of $120,000 is made then the level of the river as a result of these two transactions rises by $120,000 minus $2,000. On any given day, hundreds of thousands of such transactions occur. It is the net of them that determines the money supply.

Simple enough. But then it gets more complicated. There is not just one money supply, there are many money supplies. Why?

Money lent into existence when an auto loan is taken out does not enter or leave the river of money the same as money lent into existence when a mortgage is taken out or when a television is purchased with a credit card. The two most distinct money supplies are those that result from asset transactions and the one that results from goods, services, and wages payment transactions. The great difficulty and confusion in measuring inflation under our system is that the money supply for assets is not measured the same as for goods, services, and wages. There is no M3 for assets. - Eric Janszen
It gets worse. A high rate of asset price inflation is the objective of monetary policy while a low rate of commodity and wage inflation is a separate objective. Plus asset price deflation can influence goods and wage prices through wealth effects and unemployment.

dummass
03-01-10, 05:25 PM
EJ is writing a slew of Positions on Topics essays that we can all refer to in order to settle these disputes.


Thanks for the preview Fred, but we already have proof that money destruction is not happening in the way Sharky suggests. If it were, we would be in a deflationary spiral. Obviously, something is amiss.

I look forward to the new feature. :)

Sharky
03-02-10, 01:43 AM
Maybe I'm not using the same definition of money as others here? I'm including credit money (checkable deposits), as well as cash (FRNs): M1 or M2 + bank reserves, not just M0.


The banks' bad assets became both the Fed's liability and its assets. The asset-backed securities and agency debt became deposits on the Fed's account. Not a penny was printed, and assets minus liabilities remains nearly the same. Neat, eh?

All money creation by the Fed works in a similar way. A typical transaction would add to Treasuries on the asset side, and to the depository institution balance on the liability side (that amount plus vault cash is bank reserves).

Deposits held for depository institutions went up by $1.2T. What do you call that, if not credit money?

FRNs (actual printed money) only come into existence at a bank's request, in exchange for an amount they already have on deposit with the Fed.


In a Positions on Topics on money creation, he explains that money is not destroyed via defaults. Money is only removed from the flow of money in the system when a loan is repaid.

Please explain the accounting transactions that happen at a bank when a borrower defaults and that default is recognized (booked) by the bank (assume an unsecured loan). The loan, which is an asset, will have zero value. What is the offsetting accounting entry for the charge-off?

The way I understand it is as follows: first, banks estimate future losses from bad loans. Then they take periodic charges against earnings (capital) to fund an Allowance for Loan and Lease Losses (ALLL) account (which moves Tier 1 into Tier 2 capital). When loan losses actually occur, they are then charged to the ALLL. The ultimate result is a destruction of bank capital.

Is there something about that process that you don't agree with? Or is bank capital not "money" by the definition you're using?

FRED
03-02-10, 11:08 AM
Maybe I'm not using the same definition of money as others here? I'm including credit money (checkable deposits), as well as cash (FRNs): M1 or M2 + bank reserves, not just M0.

All money creation by the Fed works in a similar way. A typical transaction would add to Treasuries on the asset side, and to the depository institution balance on the liability side (that amount plus vault cash is bank reserves).

Deposits held for depository institutions went up by $1.2T. What do you call that, if not credit money?

I was referring to the process of halting deflation, not creating inflation. But yes, the process of money creation is similar. The Fed can borrow money into existence to lend to banks, the government can lend money into existence to lend to itself, and so on.


FRNs (actual printed money) only come into existence at a bank's request, in exchange for an amount they already have on deposit with the Fed.Yes. Note that the Fed's liabilities were 92% FRNs before the crisis and are now only 40% of liabilities. As we forecast here, the Fed monetized the asset-backed securities of commercial banks and financial institutions. Those who argued a deflationary outcome with us in 2006 claimed that was not going to happen. The net result is that the banks that held them lived to lend another day rather than being allowed to fail as in the 1930s.


Please explain the accounting transactions that happen at a bank when a borrower defaults and that default is recognized (booked) by the bank (assume an unsecured loan). The loan, which is an asset, will have zero value. What is the offsetting accounting entry for the charge-off?Step 1. $100,000 is loaned into existence when Joe borrows $100,000 to fix his house.
Step 2. $20,000 goes to building materials. $20,000 is transferred from Joe's account to the building material company's. From there $10,000 goes to wholesale suppliers, $5,000 to payroll, $2,000 to taxes, and so on. From there, from the account of each supplier, money goes on to make to payroll, pay taxes, etc. The original $100,000 borrowed into existence by Joe spreads in this way throughout the economy. It is in the great river of money.
Step 3. Previously we covered the case where Joe pays off the loan by installments. In the process of repaying the loan, he dips into the river of money for $2,000 and lowers the level by $2,000. If however he simply defaults on the loan, no money is extracted from the river of money. The level stays the same. The net result is the equivalent of quantitative easing, with money created without an offsetting liability.


The way I understand it is as follows: first, banks estimate future losses from bad loans. Then they take periodic charges against earnings (capital) to fund an Allowance for Loan and Lease Losses (ALLL) account (which moves Tier 1 into Tier 2 capital). When loan losses actually occur, they are then charged to the ALLL. The ultimate result is a destruction of bank capital.

Is there something about that process that you don't agree with? Or is bank capital not "money" by the definition you're using?We disagree about the net result of the process. The destruction of bank capital does not remove money from the river of money that flows through the economy. To the extent that it reduces the bank's future lending, and thus the rate of new money addition to the river relative to withdrawl via loan repayent, the net result of the destruction of bank capital may be a reduction in the level of the river of money. The impact on the money supply and inflation is indirect. The government can make up for this decrease in private sector borrowing by increasing its own borrowing. Its ability to do so is infinite, and the extent of its use of this ability purely a matter of policy not any limitation in the tools available to it.

We forecast and continue to expect a similar relationship between government spending and the money supply as occurred in Japan since 1993.


http://www.itulip.com/images/japanmoneysupply.gif

Sharky
03-02-10, 04:15 PM
Step 1. $100,000 is loaned into existence when Joe borrows $100,000 to fix his house.
Step 2. $20,000 goes to building materials. $20,000 is transferred from Joe's account to the building material company's. From there $10,000 goes to wholesale suppliers, $5,000 to payroll, $2,000 to taxes, and so on. From there, from the account of each supplier, money goes on to make to payroll, pay taxes, etc. The original $100,000 borrowed into existence by Joe spreads in this way throughout the economy. It is in the great river of money.
Step 3. Previously we covered the case where Joe pays off the loan by installments. In the process of repaying the loan, he dips into the river of money for $2,000 and lowers the level by $2,000. If however he simply defaults on the loan, no money is extracted from the river of money. The level stays the same. The net result is the equivalent of quantitative easing, with money created without an offsetting liability.

We disagree about the net result of the process. The destruction of bank capital does not remove money from the river of money that flows through the economy. To the extent that it reduces the bank's future lending, and thus the rate of new money addition to the river relative to withdrawl via loan repayent, the net result of the destruction of bank capital may be a reduction in the level of the river of money. The impact on the money supply and inflation is indirect. The government can make up for this decrease in private sector borrowing by increasing its own borrowing. Its ability to do so is infinite, and the extent of its use of this ability purely a matter of policy not any limitation in the tools available to it.

We forecast and continue to expect a similar relationship between government spending and the money supply as occurred in Japan since 1993.

I'm not questioning that the Fed or the Treasury can step in and change the amount of money in circulation. Rather, I was looking at the process of money creation and destruction by banks alone; what the gov does or doesn't do is independent of what the banks do.

The two statements in bold above seem to contradict each other. You seem to agree that a loan default does destroy bank capital. Is that right? If so, do you also agree that bank capital is money? Why shouldn't that capital be considered an offsetting liability to the defaulted loan?

Assuming the government doesn't step in, how is bank capital replenished? Banks have stockholders, right? So if a bank sells stock to replenish lost capital, wouldn't that draw from your "river of money"?

Another way to look at it is that interest payments on loans normally flow from the "river of money" into banks, where they become income. Banks then usually have the option of spending those earnings back into the economy (as any company or individual does). However, a provision for loan and lease losses is directly written off against that income. That portion of income therefore cannot be spent back into the economy, and is removed from circulation when losses are recognized, since the provision and the associated charge-offs aren't expenses in the traditional sense: they don't flow out to some other party.

jimmygu3
03-03-10, 06:05 PM
Think of the money supply as a river of money that money flows in to and out of resulting from thousands of transactions conducted through thousands of pipes.

The Input pipes are the pipes that carry the money from a lender, money that is created when money is lent into existence and added to the river of money. The Output pipes carry money back out of the river to a lender as a loan is repaid. The level of the river of money, the total money supply, is determined by the relative rate of creation of new money, money added to the river via loans, versus the rate of old money removed from the river via loan repayment.

The part that trips up most people is this: it's not the same money, that is, the money repaid is not the same as the money that was created. Once the money is lent into existence and enters the river it spreads throughout the economy. There is no trail of bread crumbs that ties the dollars of the original loan back to the original lender. The new money created by a loan leaves the borrower's bank account as it is spent. There it moves to another person's account and is then re-spent. And on and on it goes, down the river, spreading and dissipating into the great flow. Throw a glass of water into a river, then try to go get it back. Good luck!

When a debt is repaid, an amount of money equal to the amount of money created money, plus interest, is withdrawn from the river of money. But loans are rarely repaid at once, but rather as a series of payments.

If the river of money flows at 1 billion dollars per hour, then a payment of $2,000 on a $100,000 loan equals a reduction of 1 millionth in the total flow. If at the same time a new loan of $120,000 is made then the level of the river as a result of these two transactions rises by $120,000 minus $2,000. On any given day, hundreds of thousands of such transactions occur. It is the net of them that determines the money supply.

Simple enough. But then it gets more complicated. There is not just one money supply, there are many money supplies. Why?

Money lent into existence when an auto loan is taken out does not enter or leave the river of money the same as money lent into existence when a mortgage is taken out or when a television is purchased with a credit card. The two most distinct money supplies are those that result from asset transactions and the one that results from goods, services, and wages payment transactions. The great difficulty and confusion in measuring inflation under our system is that the money supply for assets is not measured the same as for goods, services, and wages. There is no M3 for assets. - Eric Janszen


When money is created by a lender, there is also a greater liability created for the borrower, due to interest. The total of all Inputs is therefore less than the amount required for the future offsetting Outputs. In other words, there is not enough water in the river for the system to function without greater future loans made to create money to pay off the old loans, further compounding the inevitable shortage.

As Fred mentioned, defaults are one way money stays in the river, but lenders charge interest rates that well exceed the default rate, over the long term. So the system only functions when the growth in Inputs (loans) increases exponentially, to match the rate of future Output (repayment) growth due to compound interest. Or when the government pours money into the river via quantitative easing, aka printing.

This seems to me to be the stage we have entered. We are not going to see exponential growth in private credit, and although the US gov't would love to think that exponential growth in Treasury issuance will be supported, it soon won't be.

The jig is up- it's a rigged game. The only way for the river to function is through QE. The real question is, will the American people fill our cups from the QE spigot, or will big banks and institutional investors be the only beneficiaries, unloading bad assets at fictitious value in exchange for freshly minted dollars with which to pay fat salaries? Then if we're lucky it trickles down into the service economy so waitresses and cabbies can pay their rent.

Is it such a ridiculous idea to simply give every US citizen $10,000? Unlike bank bailout money, it would be instantly spent into the real economy and get things moving again. And $3T, the cost of such an endeavour, doesn't sound like as much as it used to. :D

Likewise, why not balance the federal budget over the next few years, and admit that the national debt will never be paid off. Cap the debt, continue to roll it over through new issuance but pay interest with printed money rather than increasing the debt. My hunch is that investors' negative reaction to the QE would be offset by the positive reaction to the balanced budget.

I think it could work. Anyone else?

-Jimmy

Sharky
03-03-10, 08:59 PM
When money is created by a lender, there is also a greater liability created for the borrower, due to interest. The total of all Inputs is therefore less than the amount required for the future offsetting Outputs. In other words, there is not enough water in the river for the system to function without greater future loans made to create money to pay off the old loans, further compounding the inevitable shortage.

This is only true when interest is allowed to excessively compound or when an economy suffers an unexpectedly large decline in productive output (one way to think of a loan is that the principle portion is a lien against the borrower's current assets, while the interest portion is a lien against their future productivity / earnings). In the normal situation, interest flows from borrowers back to the banks as earnings, and from there, banks either spend it back into the economy in the form of things like salaries, real estate, furniture, computers, etc, or they distribute it to shareholders in the form of dividends, from where it can also be spent into the economy. From there, the same money can be used to pay interest again.

The point here is that money can be used more than once: it circulates.


Likewise, why not balance the federal budget over the next few years, and admit that the national debt will never be paid off.

No only won't the national debt ever be paid off, it can't be paid off. If it was, all money (US dollars) would disappear from the economy. To pay it off requires destroying money (when the Treasury pays off debt held by the Fed, the associated money is destroyed, just as it's created when the Fed originally buys the debt). To pay it all off requires destroying all money (technically, paying it off would destroy bank reserves, but without reserves, banks can't make loans, so the money they create would have to vanish too).

jimmygu3
03-04-10, 12:07 AM
This is only true when interest is allowed to excessively compound or when an economy suffers an unexpectedly large decline in productive output (one way to think of a loan is that the principle portion is a lien against the borrower's current assets, while the interest portion is a lien against their future productivity / earnings). In the normal situation, interest flows from borrowers back to the banks as earnings, and from there, banks either spend it back into the economy in the form of things like salaries, real estate, furniture, computers, etc, or they distribute it to shareholders in the form of dividends, from where it can also be spent into the economy. From there, the same money can be used to pay interest again.

The point here is that money can be used more than once: it circulates.


Thanks for pointing that out, Sharky. You're right that interest payments remain a part of the money supply. By similar logic, I would also argue that defaults do not increase the money supply, as the bank must take money that would otherwise be spent back into the economy and instead use it to cover the bad debt.



Not only won't the national debt ever be paid off, it can't be paid off. If it was, all money (US dollars) would disappear from the economy. To pay it off requires destroying money (when the Treasury pays off debt held by the Fed, the associated money is destroyed, just as it's created when the Fed originally buys the debt). To pay it all off requires destroying all money (technically, paying it off would destroy bank reserves, but without reserves, banks can't make loans, so the money they create would have to vanish too).


On the contrary, the national debt could be paid off with printed money and it would greatly increase the money supply. Not that I am advocating that. :)

-Jimmy

Sharky
03-04-10, 09:29 PM
On the contrary, the national debt could be paid off with printed money and it would greatly increase the money supply. Not that I am advocating that.

Good point. I should have said that it can't be paid off with the monetary system the way it is today, where the Treasury does not normally have the ability to create (print) new money, and where all new money is borrowed into existence.

Jim Nickerson
03-06-10, 12:05 AM
ROSENBERG 3/5/2010


The widespread business focus is on rationalization and improving operational efficiencies why bother adding more plant, equipment and bodies when companies are able to churn out record 7% productivity growth as they have over the past three quarters?

This by no means suggests that the labour market will not continue to heal but if the data we received today are any indication, it promises to be a slow grind. To get back to the full employment, we will need to see 12 million jobs created and here we are still waiting for the losses to come to an end. Until we get there, and it could take anywhere from 5 to 10 years, then expect deflation to be the primary trend in the future. Deflation in wages, rents and credit are hardly the hallmarks of a background conducive to anything other than lower bond yields, an obviously murky fiscal outlook and periodic counter-tend gyrations in market interest rates. {JN emphasis}

vinoveri
03-06-10, 11:23 AM
If however he simply defaults on the loan, no money is extracted from the river of money. The level stays the same. The net result is the equivalent of quantitative easing, with money created without an offsetting liability.





This simple illustration is in fact all that needs to be understood by the people in order to effect change I believe. Defaulted debt being monetized (read: give money to banks to prevent their insolvency), and the liability spread to everyone in the form of dollar devaluation and eventual inflation). The injustice is so rank as to be almost unbelievable, ... but of course the public must come to understand what has happened else positive reform will be waiting another catastrophe.

I agree in principle with Jimmy. Although it would majorly impact the control of the oligarchy, QE in the form of limited duration debit cards (use it or lose it) to all americans is clearly more equitable. If the gov is going to print $, then distribute to all (including the savers who's wealth is debased), vs giving to the banks to lend to the public ... WFT, why can't people see the insanity of that?

metalman
03-06-10, 02:54 PM
This simple illustration is in fact all that needs to be understood by the people in order to effect change I believe. Defaulted debt being monetized (read: give money to banks to prevent their insolvency), and the liability spread to everyone in the form of dollar devaluation and eventual inflation). The injustice is so rank as to be almost unbelievable, ... but of course the public must come to understand what has happened else positive reform will be waiting another catastrophe.

I agree in principle with Jimmy. Although it would majorly impact the control of the oligarchy, QE in the form of limited duration debit cards (use it or lose it) to all americans is clearly more equitable. If the gov is going to print $, then distribute to all (including the savers who's wealth is debased), vs giving to the banks to lend to the public ... WFT, why can't people see the insanity of that?

the existence of this thread says that even itulipers don't get it. the risk of deflation ended in the usa in 2009...





http://www.itulip.com/forums/../images/cpi2000-Aug2009.gif

The U.S. experienced a short bout of deflation we call disinflation before
the long-term inflation trend resumed


http://www.itulip.com/forums/../images/cpi192801935.gif

This is what a deflation spiral looks like, from 1930 to 1934

August 2009 FIRE Economy Depression update Part I: Snowball in Summer - Eric Janszen (http://itulip.com/forums/showthread.php?p=116417#post116417)

if after all the theory & accurate predictions here the deflation question is still raised here... well... there's no chance whatsoever that the ave. joe will ever understand how he's getting f&cked.

Jim Nickerson
03-17-10, 12:32 AM
http://www.zerohedge.com/article/albert-edwards-predicts-deflation-followed-double-digit-inflation-governments-opt-default-an


Ultimately, as my colleague Dylan Grice writes, I think we head back to double-digit inflation rates as governments opt to default. I certainly again expect to see CPI inflation above 25% in the UK and indeed in most developed nations in my lifetime ? I have happy memories of the three-day week and doing my homework by candlelight. In the near term, however, the deflationary quicksand will suck us ever lower until we suffocate. A key driver for underlying inflation remains unit labour costs. While unit labour costs decline at an unprecedented rate, they are sucking us inevitably into a Fisherian, debt-deflation spiral. Only then will we see how far policymakers are willing to go to debauch the currency. Last year saw them cross the Rubicon. Monetisation is now the policy lever of first resort.
http://www.zerohedge.com/sites/default/files/images/user5/imageroot/Edwards%20-4%203.16_0.jpg (http://www.zerohedge.com/sites/default/files/images/user5/imageroot/Edwards%20-4%203.16.jpg) I don't know whose emphasis that is. Either Edwards' or zerohedge's.

I think if one is using the time scale of a child to be born 1000 years from now, then perhaps hyperinflation is right around the corner.

For those of us who live in the current period with daylight savings time and life span's generally less than 100 years, the "corner" might be down the pike a bit.

metalman
03-17-10, 12:50 AM
http://www.zerohedge.com/article/albert-edwards-predicts-deflation-followed-double-digit-inflation-governments-opt-default-an

I don't know whose emphasis that is. Either Edwards' or zerohedge's.

I think if one is using the time scale of a child to be born 1000 years from now, then perhaps hyperinflation is right around the corner.

For those of us who live in the current period with daylight savings time and life span's generally less than 100 years, the "corner" might be down the pike a bit.

morons expect deflation or hyperinflation. gov't learned more subtle ways of wealth redistribution via cds etc. just ask the boyz at goldman sacks. but the currency falls and gold goes up.

aaron
03-17-10, 12:57 AM
Bernanke will go down in history as the man who paid off the national debt. God bless the man!

And he saved the world economy too.