The Money Illusion

[scepticus]

Where are they going to export the hyperinflation to?

What we are seeing, I think, is a change in the nature of that beast capital. I know for you capital will always be an autarchic concept, but for everyone else, life goes on. For everyone else, my answer is this:

Looking at the world and human relationships in terms of capital labour and land is only one way of looking at things, an abstraction that has served reasonably well for a period. Other abstractions may serve equally well or beter, depending on circumstances It seems to me that the notion of financial capital is moving towards something more akin to Consumption Drawing Rights. A balance of consumption allotted to you by society/the system.

That way of looking at things makes more sense in a world constrained by the rising consumption of others and energy scarcity. I also think it better fits the world view of most of the people of the west. It certainly is a better description of zirpworld than capitalism.

The hyperinflation as injin puts it has already happened - you just have to look at the charts to see that. That inflation wasn't japans fault - it was due to the amount of money masquerading as government debt that was being pumped out.

I don't see any hyper inflation or hyper deflation in our future, just a rather long interregnum during which money and the culture that surrounds it adapts after a century or so of swimming against the tide and the majority of the liquidity created the last 50 years leaks back out of the economy. It'll likely be quite boring.

[Injin]

What we are seeing, I think, is a change in the nature of that beast capital. I know for you capital will always be an autarchic concept, but for everyone else, life goes on. For everyone else, my answer is this:

Looking at the world and human relationships in terms of capital labour and land is only one way of looking at things, an abstraction that has served reasonably well for a period. Other abstractions may serve equally well or beter, depending on circumstances It seems to me that the notion of financial capital is moving towards something more akin to Consumption Drawing Rights. A balance of consumption allotted to you by society/the system.

That way of looking at things makes more sense in a world constrained by the rising consumption of others and energy scarcity. I also think it better fits the world view of most of the people of the west. It certainly is a better description of zirpworld than capitalism.

The hyperinflation as injin puts it has already happened - you just have to look at the charts to see that. That inflation wasn't japans fault - it was due to the amount of money masquerading as government debt that was being pumped out.

I don't see any hyper inflation or hyper deflation in our future, just a rather long interregnum during which money and the culture that surrounds it adapts after a century or so of swimming against the tide and the majority of the liquidity created the last 50 years leaks back out of the economy. It'll likely be quite boring.

Japan kept going by nuking the yens value and hyperinflating the globe using low interest rate policy.

I ask again - where is the hyperinflation going to go in your scenario?

because if it doesn't go somwhere then the currency will be utterly destroyed in short order.

[scepticus]

I ask again - where is the hyperinflation going to go in your scenario?

and I'll tell you again, the hyperinflation has already occurred.

if our rates are much lower than the rest of the world there will be a carry trade for a while (assuming there are no capital controls put in place) but no hyperinflation.

UK prices were super-inflating long before japan went down.

[Injin]

and I'll tell you again, the hyperinflation has already occurred.

Then how are we going to be the same as japan?

their solution was to hyperinflate further and export it. If that's off the table then japan we aren't going to be.

if our rates are much lower than the rest of the world there will be a carry trade for a while (assuming there are no capital controls put in place) but no hyperinflation.

UK prices were super-inflating long before japan went down.

SOoooooo..... where is the hyperinflation going?

or are we now not going japanese?

[scepticus]

data on the japanese exported hyperinflation please. quantitative data on its effect on western prices please.

I have provided agood deal more actual dat ato make my case here than you have. You have presented none at all.

No data, no talkies.

[scepticus]

isn't that what we do on HPC?

[Injin]

isn't that what we do on HPC?

It is.

http://www.oftwominds.com/blogaug10/Japan-doomed07-10.html

[sharpe]

More data: money multipliers (velocity)

Note that US M2 historically has velocity=8. Gilts have about the same. Above US M2 sits another tower of lending facilitated by circulation of M2/M1/M0, and I think you'll find another tower of lending (what is left of that portion of the shadow banking system run out of the UK) sits atop the circulation of gilts.

Is the key to this argument explaining why velocity is equal to fractional reserve effect or money multiplier?

I have not understood why you think they are the same?

[scepticus]

Scepticus is the thrust of your point that because the liquidity of tradable assets has been increased by the likes of new technology, market structures etc., that in fact this has had the effect of increasing the 'money supply' with money-like substitutes?

well that is exactly the point with respect to government bonds. A market exists which confers upon them a similar velocity to that which the commercial bank system confers upon base money. Given that both asset classes are nominal risk free bonds, they must both be money with an inflationary effect in proportion to velocity. Here my aim is to link the prior great inflation with the ramping up of government debt velocity. It is only cultural norms that prevent us from seeing this reality.

with regard to equities and other highly traded markets, my point is more theoretical and more forward looking. While high volumes on equity markets have certainly contributed to the inflation of equity prices (and erosion of yields as per the case shiller adjusted S+P graph above) , it is more difficult to implicate equity volume inflation in general goods price inflation. If you look at daily moves of any of the main benchmark ETFs then their daily moves imply a liquidity that is considerably more fragile than that in forex markets. My point is more to view equities and various flavours of ETFs as competing currencies and from that make predictions about a future where private currencies are more commonplace ( Greenspan has said he expects that to be a feature of C21st)

I certainly do believe that electronics has had as big a part in recent inflation as financial deregulation and the closing of the gold window has done.

[scepticus]

In that case, as central bank money has to follow bonds round the system as they are traded

I'm not sure why that is the case. I am assuming bonds trade in many circumstances without any base money changing hands. Bonds may trade

Consider for example an interbank repo market with one bank swapping a gilt in exchange for MBS or CDO collateral. Normally the bank posting the collateral would take a haircut, e.g. they'd have to put up CDO collateral with a greater face value than the bond, due to the risk an illiquid of the collateral.

Also, is it not the case that Gilts in the UK benefit from the CREST trading system?

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

It seems to me this is a central clearing house facility which does not involve the transferral of base money except for trades which have failed to settle correctly.

The existence of a separate clearing house (e.g. not the BoE) for gilts should set the alarm bells ringing...

I'm not 100% up to speed with how crest and the secondary market actually works so I'm happy to be corrected on this point. B'stard would likely know the answer.

[scepticus]

Also, a stronger argument for bond related velocity that I forgot to include in my original write up is that bonds facilitate international capital flows.

Look at the foreign holdings of US and UK bonds. Without those bonds, that capital flow could only have been facilitated by depositing the inflow into UK and US commercial banks. In order to sustain this those banks would have had to have lent EVEN MORE money to the UK and US private sector.

There is no base money at international level, so perhaps the reason that the impact on domestic base money velocity seems absent is because global public debt is the enabler for international capital flows, the driver of globalisation if you like.

[Alan B'Stard MP]

I'm not sure why that is the case. I am assuming bonds trade in many circumstances without any base money changing hands. Bonds may trade

Consider for example an interbank repo market with one bank swapping a gilt in exchange for MBS or CDO collateral. Normally the bank posting the collateral would take a haircut, e.g. they'd have to put up CDO collateral with a greater face value than the bond, due to the risk an illiquid of the collateral.

Also, is it not the case that Gilts in the UK benefit from the CREST trading system?

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

It seems to me this is a central clearing house facility which does not involve the transferral of base money except for trades which have failed to settle correctly.

The existence of a separate clearing house (e.g. not the BoE) for gilts should set the alarm bells ringing...

I'm not 100% up to speed with how crest and the secondary market actually works so I'm happy to be corrected on this point. B'stard would likely know the answer.

The CREST system consists of about 30000 members who hold money & securities accounts with one of the numerous CREST settlement banks. Each settlement bank will maintain a CREST settlement account at the BoE. It is a delivery-versus-payment system - so a securities transfer does require a payment. Because CREST is effected over the central bank RTGS (real-time gross settlement) system - the payment between different settlement banks is base money.

CREST settlement banks will usually maintain during the day a balance in their CREST (not reserve) accounts. If they hold no balance - they can obtain intra-day liquidity from the central bank using short duration repo.

I had some volumes for CREST somewhere - I'll see if I can dig it out.

Edited August 4, 2010 by Alan B'Stard MP

[scepticus]

The CREST system consists of about 30000 members who hold money & securities accounts with one of the numerous CREST settlement banks. Each settlement bank will maintain a CREST settlement account at the BoE. It is a delivery-versus-payment system - so a securities transfer does require a payment. Because CREST is effected over the central bank RTGS (real-time gross settlement) system - the payment between different settlement banks is base money.

CREST settlement banks will usually maintain during the day a balance in their CREST (not reserve) accounts. If they hold no balance - they can obtain intra-day liquidity from the central bank using short duration repo.

I had some volumes for CREST somewhere - I'll see if I can dig it out.

OK thanks, so then my argument hangs on:

1) on bilateral repos, swaps and so on conducted between individual banks which don't involve base money

2) international flows facilitated by bonds

3) and this:

This shows a significant secular change in velocity of money from about 1979 (albeit with a recessionary blip 82-88 (however if you plotted a moving average of velocity it would trend upwards from about 1973.

So I'm not sure about HAMs suggestion that bond velocity doesn't show up in base money velocity

[Alan B'Stard MP]

OK thanks, so then my argument hangs on:

Why? If the net flow between settlement banks are in balance - which you'd expect over time - you still have to consider the effects of the sum flow? Have I missed something - should I read the whole thread ! The accounts that the 30000 members hold won't be cash accounts I feel.

Edited August 4, 2010 by Alan B'Stard MP

[scepticus]

Why? If the net flow between settlement banks are in balance - which you'd expect over time - you still have to consider the effects of the sum flow?

I think HAM is suggesting that if that is the case then it should show up in velocity of base money? And actually the graph I have posted does show a secular increase in velocity from the mid 70's.

Have I missed something - should I read the whole thread !

If you could possibly spare the time I'd appreciate it...

The accounts that the 30000 members hold won't be cash accounts I feel.

not sure what you mean by 'not cash accounts'

[Alan B'Stard MP]

I think HAM is suggesting that if that is the case then it should show up in velocity of base money? And actually the graph I have posted does show a secular increase in velocity from the mid 70's.

If you could possibly spare the time I'd appreciate it...

I'll have a look. Theory makes my head spin as you know

not sure what you mean by 'not cash accounts'

Bank credit. I've never seen a CREST account up-close-and-deletable myself so can't comment on its nature.

[scepticus]

[quote name='Alan B'Stard MP' date='04 August 2010 - 11:16 AM' timestamp='1280920602' post='2653425'

Bank credit. I've never seen a CREST account up-close-and-deletable myself so can't comment on its nature.

of course. So in that case is it correct to say that bond trading is increasing the velocity of broad money? My head is hurting now too.

[Alan B'Stard MP]

of course. So in that case is it correct to say that bond trading is increasing the velocity of broad money? My head is hurting now too.

Well I suppose you just have to imagine the bond is a tin of beans on a shelf in sainsburys - and you are buying it with your debit card. That is a sufficient analogy to a point. I say to a point because in the bond-world the Banks are also grocers and have J6P and other bankers doing their weekly shop with them - using their own type of respective debit card.

Edited August 4, 2010 by Alan B'Stard MP

[scepticus]

Well I suppose you just have to imagine the bond is a tin of beans on a shelf in sainsburys - and you are buying it with your debit card. That is a sufficient analogy to a point. I say to a point because in the bond-world the Banks are also grocers and have J6P and other bankers doing their weekly shop - using their own type of respective debit card.

so you are agreeing that maybe all the effects of a liquid market in bonds don't show up in base money velocity?

[Alan B'Stard MP]

so you are agreeing that maybe all the effects of a liquid market in bonds don't show up in base money velocity?

Well I would have to scratch my head - but I don't know what base money has to do with it. It is only a settlement asset - to enable flow of financial capital.

If over time the net flows between settlement banks are zero - as you might expect in a chaotic system - or a system where the bank wishes to remain solvent - then I would proffer that the base money movement is an irrelevance. It's the movement of peoples' capital that is key.

If 1/14th of transactions take place inside an institution - the base money will have no involvement in such cases. Is this perhaps the difference you are looking for?

Edited August 4, 2010 by Alan B'Stard MP

[scepticus]

Well I would have to scratch my head - but I don't know what base money has to do with it. It is only a settlement asset - to enable flow of financial capital.

well, to test my theory I need to show some effect of both increases net stock of bonds and increased velocity of bonds, that links both increased stocks and velocity of these to actual prices of real goods and other non financial assets.

If over time the net flows between settlement banks are zero - as you might expect in a chaotic system - then I would proffer that the base money movement is an irrelevance. It's the movement of peoples' capital that is key.

I see what you are saying. If balances between 2 players net out with high frequency then base money movement is not required for many transactions. Base money would only move between two institutions when they had exceeded whatever bi-lateral credit has been extended between them.

Therefore while counterparty confidence is high many settlements simply won't show up in official velocity figures, but these settlements will affect prices (or rather, the perceived ability to easily make future settlements will affect real prices.

[Alan B'Stard MP]

well, to test my theory I need to show some effect of both increases net stock of bonds and increased velocity of bonds, that links both increased stocks and velocity of these to actual prices of real goods and other non financial assets.

Sorry, I've yet to read the thread in full. Bed beckons.

I see what you are saying. If balances between 2 players net out with high frequency then base money movement is not required for many transactions. Base money would only move between two institutions when they had exceeded whatever bi-lateral credit has been extended between them.

I am saying its irrelevant. Today I pass you money. Tomorrow you pass it back to me. Net effect is zero - but some bidding on bonds happened on the way.

Banks will have to manage their net flows of cash between them as part of their cash management function - in whatever business they do. You can't have all the liquidity slowly accumulating at one end of the pool - because participants didn't match their cash funding with their cash outflows. I'm not saying the banks do have zero net flows between them - but the system will inherently try to balance itself over time as each bank performs the cash management function.

Given this, and given banks will defer-net-settle their other types of business - what has base money got to do with velocity? A days debit card transactions between banks could be 10 / 9 or 100,000 / 99,999. The net settlement at days end will still be 1 base money. The movement of $1 gives no insight to the actual flow of financial "capital" and the trading that necessitated it.

Therefore while counterparty confidence is high many settlements simply won't show up in official velocity figures, but these settlements will affect prices (or rather, the perceived ability to easily make future settlements will affect real prices.

No, all settlements will occur and be will be recorded in whatever manner - if through CREST and RTGS. What happens in a CREST settlement institution (of which there are I believe 14) - when the two contracting parties (or agents) involved are members of that institution - I don't know.

Edited August 4, 2010 by Alan B'Stard MP

[sharpe]

well, to test my theory I need to show some effect of both increases net stock of bonds and increased velocity of bonds, that links both increased stocks and velocity of these to actual prices of real goods and other non financial assets.

I see what you are saying. If balances between 2 players net out with high frequency then base money movement is not required for many transactions. Base money would only move between two institutions when they had exceeded whatever bi-lateral credit has been extended between them.

Therefore while counterparty confidence is high many settlements simply won't show up in official velocity figures, but these settlements will affect prices (or rather, the perceived ability to easily make future settlements will affect real prices.

Could I repeat my question. Why is velocity comparable with the money multiplier? (By money multiplier I mean 1/(fractional reserve requirement)

[scepticus]

oops, sorry I misread your question sharpe. And I realise I have indeed made a mistake previously.

The bit about the reserve requirements no longer applying is still valid, but you are right - I have compared velocity of gilts (7) to the effective money multiplier for the various money aggregates - which is quite wrong.

the chart it needs to compare with is the velocity chart given earlier in response to HAM's comment (unfortunately this chart is for the US...).

[edit 2: here is the chart]

Edited August 4, 2010 by scepticus

[Panda]

Sceppy............

Yep i agree, i also think we are in for the Japan model, also the US, Japan are for all intense and purposes are 20 odd years ahead of us all. Regarding exporting inflation, i do not think we will see hyperinflation of wages, only modest rises below cost inflation in any sense. For me its;

Falling asset values, a slow long way down,rising costs of living outstripping wage inflation, so no real growth in wages just a long slow reduction in purchasing power of your savings and wages. This along with next to no yield of liquid assets, a flattening out of the yield curve for the next ten years..............

So wages and savings being eroded through cost inflation outstripping interest rates and wage demands.

For me its work longer and harder for less, if you have no debt great, if you do, it will be a long haul to pay it down. If you are holding cash/bonds, cost inflation will make a significant dent in it, but it will keep pace with wage inflation if you hunt round for the best interest paying accounts.....................