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mattyboy1973

Loan Writeoffs And Their Effect On The Money Supply

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Like many I am a novice in these matters and confused about what the effects of loan write downs really is on the money supply and ergo price inflation, and what difference government bailouts might make.

I have some questions:

1. If a loan (eg a mortgage) is written off by the bank - this money stays in the money supply (if it was paid back, the original loan amount would be written off ('disappeared'), and the interest retained by the bank??) - if this is correct, why are loan write-downs deflationary?

To follow up 1. - an explanation often touted is that the bank cannot then further lend (after a write down), and that its capacity to lend is reduced 9 times (or insert fractional reserve requirement figure) due to the requirements of fractional lending. Is this true? Why would it be true that the bank can lend 9x its reserve for the purposes of this loan, but if the loan is not paid back it effectively loses its reserve capacities x 9 ? Why is this not a 1-1 ratio to its future lending capacity, therefore (with money left 'in the system' as a result of 1, a net zero effect on the money supply?)

3. If the bank is 'bailed out' by some entity (the goverment), lets say this wipes out the losses incurred in 1. - does this then mean the bank can lend again, without the money lent in 1. being 'disappeared' as it is repaid to the bank? Then - this must be inflationary, or at least it would be just as soon as the bank manages to lend the money to another 3rd party?

These may be extremely naive questions but if anyone genuinely knows the answers I would be very interested, thanks.

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A loan will consist of two book entries i its simplest form

The debt to the borrower- an asset

The pledge is secured- a liability.

say the laon is for £100 the bank has an asset earning interes of £100+interest.

It has a liability of £100

Add them up and you are left with the interest as gross profit.

If the loan defaults, the bank has to write down the £100 capital to 0, assuming no payments made.

The new balance sheet now with the banks stands at -£100- the pledge. The bank is therefore down £100 in its books.

This -£100 is now visible and they will need a reserve anount to allocate to it, to rebalance it.

Hence a £100 write off, not only loses them interest and future revenue, it also reduces the banks worth by £100. It therefore has a reduce lending capacity of £100 times whatever multiple they are allowed.

However, the assets that we hear are being written down by the £Bn are not loans, they are bonds and things that are/were treated as cash. A bond worth £100 in 2007 may be only worth £50 in 2008, thus again, the balance sheet is reduced by £50.

However, they will have lent into the real world a loan based on the value of the bond at £100. Now the bond is worth £50, they have overlent. They could be technically in breach of international banking laws and therefore technically insolvent.

The bail outs try to reblance the books by lending the banks the £100 back with good safe treasuries, while the central banks take as collateral (pledge) the devalued bond.

wish it were only £100!!

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Like many I am a novice in these matters and confused about what the effects of loan write downs really is on the money supply and ergo price inflation, and what difference government bailouts might make.

I have some questions:

1. If a loan (eg a mortgage) is written off by the bank - this money stays in the money supply (if it was paid back, the original loan amount would be written off ('disappeared'), and the interest retained by the bank??) - if this is correct, why are loan write-downs deflationary?

When a loan is created you sign an IOU to the bank, which compensates for the "money" they give you, this is an asset of the bank(or whoever buys it), so if it deteriorates in value, that institution takes the loss on the asset. Those losses are deflationary, because credit (which is the flipside of debt) acts like money in todays system. Even though its value relies on the other sides ability to repay. So writedowns are deflationary
To follow up 1. - an explanation often touted is that the bank cannot then further lend (after a write down), and that its capacity to lend is reduced 9 times (or insert fractional reserve requirement figure) due to the requirements of fractional lending. Is this true? Why would it be true that the bank can lend 9x its reserve for the purposes of this loan, but if the loan is not paid back it effectively loses its reserve capacities x 9 ? Why is this not a 1-1 ratio to its future lending capacity, therefore (with money left 'in the system' as a result of 1, a net zero effect on the money supply?)

There is really no fractional reserve anymore, banks lend everything they get their hands on. If they take losses its simply a matter of the bank taking a line of credit and using that instead. <_< (they now have more liabilities though)

3. If the bank is 'bailed out' by some entity (the goverment), lets say this wipes out the losses incurred in 1. - does this then mean the bank can lend again, without the money lent in 1. being 'disappeared' as it is repaid to the bank? Then - this must be inflationary, or at least it would be just as soon as the bank manages to lend the money to another 3rd party?

Today central banks are swapping treasuries for less liquid bank securities . Those treasuries can then be sold on the open market for extra funding. Which might be required because they have lost short term funding, loan book deterioration etc. So it could be used for lending, but since they've already swapped other securities it would be reckless to do it on a large scale.

These may be extremely naive questions but if anyone genuinely knows the answers I would be very interested, thanks.
Edited by domo

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Or to put it simply the promise of money in the future (notional money) disappears and the bank is poorer by

  • whatever they had previously counted in based on a promise but was then lost to a default

minus

  • the ammended value of the asset they have as security.

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Like many I am a novice in these matters and confused about what the effects of loan write downs really is on the money supply and ergo price inflation, and what difference government bailouts might make.

I have some questions:

1. If a loan (eg a mortgage) is written off by the bank - this money stays in the money supply (if it was paid back, the original loan amount would be written off ('disappeared'), and the interest retained by the bank??) - if this is correct, why are loan write-downs deflationary?

To follow up 1. - an explanation often touted is that the bank cannot then further lend (after a write down), and that its capacity to lend is reduced 9 times (or insert fractional reserve requirement figure) due to the requirements of fractional lending. Is this true? Why would it be true that the bank can lend 9x its reserve for the purposes of this loan, but if the loan is not paid back it effectively loses its reserve capacities x 9 ? Why is this not a 1-1 ratio to its future lending capacity, therefore (with money left 'in the system' as a result of 1, a net zero effect on the money supply?)

3. If the bank is 'bailed out' by some entity (the goverment), lets say this wipes out the losses incurred in 1. - does this then mean the bank can lend again, without the money lent in 1. being 'disappeared' as it is repaid to the bank? Then - this must be inflationary, or at least it would be just as soon as the bank manages to lend the money to another 3rd party?

These may be extremely naive questions but if anyone genuinely knows the answers I would be very interested, thanks.

These are good questions, I think. I've still some uncertainties myself about the details, but I can explain what I think I understand.

In my opinion, there are two critical concerns that you've not mentioned explicitly - the first is that not every pound in the money supply has equal status... though one might try to argue that the pound is the unit of currency value, it is a mistake to think of this value independent of when it can be spent. The second I understand less well, but relates to foreign exchange and 'foreign portfolio investment' - I'll try to hint as to what I think is relevant with this.

So, first things first: there are various formal distinctions between different segments of the money supply... for which I give vastly simplified explanations :

M0 - Notes and coins (and treasury bills - erm.. BoE reserve accounts too)

M1 - Deposits in current accounts

M2 - M1 + immediately accessible savings accounts

M3 - M2 + term deposits (1 year bonds etc.)

M4 - A hotchpotch of almost everything money-like including mortgage backed securities; securitized credit card debt; corporate debt - etc.

M0 is what we use for black-market trade... it matters how often it is used, but not so much how much there is in total.

M1 can go down if people put money into savings accounts; term bonds - or invest it in their pensions... (pensions might buy secutitised debt) - or when fractional reserve borrowing is paid down.

M1 can go up if people are forced to draw down their savings or if they liquidate the term accounts - or when payments are received by third parties borrowing on fractional reserve, or from international money markets - maybe indirectly.

M2 (net of M1) can go up if people feel they have a surplus in cash for their immediate needs and want to put some away for a rainy day.

M2 (net of M1) can go down if people are faced with unexpected bills, or bargains too good to miss become available.

M3 (net of M2) can go down on maturity if the money is anticipated to be needed to spend - or if no suitably desirable offers remain for the future.

M3 (net of M2) can go up if financial institutions desperately need to raise deposits without needing to hold 10% reserves for purposes of fractional reserve as they do for current accounts.

M4 is really, really odd. Not only does it include money already discussed in M0,M1,M2 and M3, but it also includes the bonds that represent money that has been paid into M1 and possibly re-distributed into M0,M2 and M3. So, some sorts of loans count twice in M4 - once counting the lender's IOU, and once counting the borrower's cash. I think it is possible for some money to be counted more than twice - for example if commercial paper (corporate bonds) are issued to pay for Asset backed securities (bundled mortgages) which then pay out cash to the house vendor... and, even then, that money might be invested in a pension - say - giving a "virtuous" cycle of M4 growth. I think M4 also includes bank deposits at other banks - i.e. intra-bank loans - or, a concept a bit like banks' current accounts.

When a loan is written off:

1. M4 might decline by the value of the written off loan (assuming the loan was packaged as a bond which counts in M4 - for example - it has a maturity of less than 5 years.)

2. Capital reserves might decline if the loan was not securitised - which might demand recapitalisation - i.e. money deducted from M1 in exchange for new shares. I'm not sure, but I think capital reserves feature in M4.

3. If the loan/credit is neither fractional reserve nor securitised - for example a bar tab - no change to monetary supply results.

To move on to the question about exaggerated restriction in future lending arising from capital adequacy constraints. I believe that such constraints are real. In reverse, option 3 for writing off a loan only applies to non-bank non-building-society loans... (loan sharking etc.) where losses result in a 1-1 restriction in future lending. Option 2 definitely does constrain the bank - unless it can acquire more funds (from M1,M2 or M3 - approximately) into its capital reserves - its lending is severely constrained. The bank might try to do this using rights issues, or by selling securitised loans to investors. Option 1 is where the fun starts... this is the debacle of the SIV. Where banks couldn't meet regulations with ultra-risky securitised debt on its balance sheet, it was allowed to start a subsidiary to hold all the risk and lend the subsidiary the money (sourced by various banks lending against fractional reserve on the money markets) to finance itself as a non-profit-making-charitable-organisation. (Don't laugh.) This appeared to work for a while because... if a normal company took lots of risks - and lost, it would be insolvent and a self-contained problem for the bankruptcy courts... the problem was the size of the SIVs - and the fact that they weren't really independent. If a SIV were to succumb to bankruptcy some disastrous consequences would emerge: (1) the short term loans on the money markets to that SIV would likely cause a chain reaction of insolvencies wiping out every bank denominated in that currency... and, even if that could be avoided by some central-bank-slight-of-hand-assistance, (2) the SIV's assets would need to be auctioned - flooding the market and causing a crash in the price of all the assets held by every bank denominated in that currency - rendering them insolvent. A further effect - as a consequence of the international nature of the money markets - the currency itself would massively devalue - leading to a likely collapse of currency. What has come to light in the past year - which the money market investors probably knew all along - is that SIVs can't be allowed to become insolvent - even if it ends up with the debt being passed on to the tax payer.

In short, a loss resulting ultimately in a reduced capital reserve at a bank results in a many times larger restriction in future lending capacity than the capital reserve loss. capital reserve losses arise too when banks are compelled to support their SIVs - or, equivalently, take SIV assets "back on balance sheet" (a bit like owning up to an old loan that had been hidden from the regulators). If capital reserves can increase, however, a many times larger relaxation in future lending capacity then arises. Capital reserves might increase if banks perform a rights issue; decide not to pay dividends; increase their profit margins - etc... but all these activities suck money from M1/M2/M3 - which is likely to lead to economic contraction.

Next, you ask about bale outs... which can come in two forms. The first kind of bale out is some form of a loan to avoid insolvency... this results in higher profit margins than would otherwise be possible, so it is a bale out of sorts, but if the cost of the loan is higher than loans were in the past (even if it is much cheaper than they would be commercially today) this does not increase the scope for future lending compared with the past. A capital injection bale-out is a different kind of bale out - an investment into the bank itself. This sort of bale out arises from rights issues and the practice of attempting to attract investment from sovereign wealth funds and private equity. These capital injection bale outs do incresae the capacity for future lending - if, and only if, the capital raised exceeds capital losses. The snag, of course, is finding investors dumb enough to sacrifice their money to bale out the reckless banks - probably for little or no reward and substantial risk of capital loss.... let's face it, the price of bank shares over the past year hardly suggests that investors are queuing up for a part of the action.

Finally, pervading all of this, is foreign exchange and the UK's national balance of payments. In recent years, 'securitisation' has allowed substantial foreign currency investment in Sterling debt... while Sterling denominated investors have been biased towards investing directly in foreign assets... rather than foreign denominated debt. Where foreign investors bought fresh securitised debt, they (indirectly) expanded M1 by way of foreign exchange - which did not decrease any aspect of UK money supply. In the opposite direction, UK M1 was used to buy foreign land, buildings, companies - etc. Sterling investors have been accruing real assets while foreign investors have been accruing sterling debt... or, very crudely, we own the stuff and owe them money that we've been borrowing from them to service our debt to them. I hope that doesn't sound nationalist/racist/culturalist - it is merely an observation about currency. While our economy was "growing" there were significant inflows of foreign cash - which was used to lubricate the financial system - our foreign investors were critical in the system that allowed British people to pile debt onto debt onto debt. This securitisation was in substantial decline - and I'm waiting for the August report - which I think will show that interest in such investments is all but over... Sterling borrowers will, IMHO, be squeezed for repayment and will not be able to continue to fund debt with more debt. M3 (i.e. solid dependable cash) is unlikely to decline (I'm saying that banks are unlikely to be allowed by the FSA/BoE to default on their depositors) but that the outlook for the more esoteric money in M4 could easily decline - and this matters... it matters a lot... especially if this affects foreign investors. Since Britain, in recent years, has exported little but debt... a change in the tastes of foreign investors may have a devastating effect on foreign exchange... arising from a balance of trade that could easily become very unbalanced. If this causes sterling to fall in value substantially, this will be reflected in the price of imported goods (almost everything) and any commodity that can be exported (specifically, oil, gas, etc.) - meaning that even though your £10,000 in the bank remains as such, it will only buy a tiny proportion of a new imported car in future - while, today, it will buy a whole one. Sterling deposits will also decline if they are used to pay down fractional reserve lending... for example if used to pay off that £10,000 0%APR balance that has been kited on credit cards for 5 years.

I hope that makes some sense (I've enjoyed clarifying my thoughts about this) - and actively welcome criticism - especially from those who understand better than I do the implications for foreign exchange...

Edited by A.steve

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These are good questions, I think. I've still some uncertainties myself about the details, but I can explain what I think I understand.

snip snip snip snip snip

I hope that makes some sense (I've enjoyed clarifying my thoughts about this) - and actively welcome criticism - especially from those who understand better than I do the implications for foreign exchange...

Trouble with you, Steve, is you make it sound so easy :lol:

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Trouble with you, Steve, is you make it sound so easy :lol:

To every simple question I can give you a thousand simple answers that are wrong. ;)

I think I've broadly grasped the nature of the money supply... I'm now struggling to get an intuition for how the international capital markets work. I know it is a complex interplay between interest rates and economic activity - but I've no clear mental model. For example, it has always puzzled me why things seem much cheaper in France/Germany than in the UK... a naive person would assume that our close trading ties with the Eurozone would mean that prices should equalise across Europe - but they haven't... not at all... which seemed very odd given that for the entire lifetime of the Euro, this disparity remained... yet the exchange rate hardly budged relative to the difference in prices.

Edited by A.steve

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To every simple question I can give you a thousand simple answers that are wrong. ;)

I think I've broadly grasped the nature of the money supply... I'm now struggling to get an intuition for how the international capital markets work. I know it is a complex interplay between interest rates and economic activity - but I've no clear mental model. For example, it has always puzzled me why things seem much cheaper in France/Germany than in the UK... a naive person would assume that our close trading ties with the Eurozone would mean that prices should equalise across Europe - but they haven't... not at all... which seemed very odd given that for the entire lifetime of the Euro, this disparity remained... yet the exchange rate hardly budged relative to the difference in prices.

I can tell you why prices are higher here.

Its not a difficult concept to grasp.

The reason is.... people are prepared to pay more than the French or Germans!

Instead of walking out of the BMW dealership in droves, they buy them at list! then they complain the cars are cheaper in Germany!

Its happened with housing, it happens in all trades.

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Have you asked yourself why the price of a pint is more in Central London than in Sheffield say?

It may give an answer you are looking for.

(Bloo Loo says it is to do with what people are prepared to pay - whilst this is true, I think that costs have a lot to do with it...starting with rents leading onto salaries and other input costs which have to be covered to stay in business...people then get used to seeing these prices and are willing to pay them as they are paid more even though they may produce the same outputs (see London weighting, differential salaries etc)).

I presume you're alluding to the cost of the premises in which to consume the pint, and of accommodation for the bar staff and dray man?

While I've not been to Sheffield for a pint, when I drank last in London, it was no more expensive than Bristol... in spite of having a view of the Thames... maybe that was because it was a bustling pub?

I'm not entirely convinced... because I think the cost of real-estate is defined primarily by ability to pay - which is defined primarily by credit - and credit by the cost of real estate and ability to service debt - with the latter mostly dependent upon creditworthiness.

My problem when thinking about Foreign Exchange is that I try to establish an opinion about why things are developing as they are - and, before long, I've gone full cycle and the trend I'm trying to explain depends upon the trend I'm trying to explain. Soros would love me for such a statement - as it corresponds to his "reflexivity" - but I can't help but think that there's something I'm missing. I believe in "reflexivity" but not as a sole explanation for a system... while Soros would hate me for such a statement - I think there needs to be an alternative model (even if it is wrong) that allows participants to rationalise - even if their rational predictions don't correspond with observed reality.

Edited by A.steve

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My problem when thinking about Foreign Exchange is that I try to establish an opinion about why things are developing as they are - and, before long, I've gone full cycle and the trend I'm trying to explain depends upon the trend I'm trying to explain. Soros would love me for such a statement - as it corresponds to his "reflexivity" - but I can't help but think that there's something I'm missing. I believe in "reflexivity" but not as a sole explanation for a system... while Soros would hate me for such a statement - I think there needs to be an alternative model (even if it is wrong) that allows participants to rationalise - even if their rational predictions don't correspond with observed reality.

Thanks for your insights Steve.

Maybe I can explain the reflexivity with the old "Company Policy + Banana" trick, I'm sure some elements could be applied to society and the banking world ?

Here is the first reference I could find from google: Company policy; No bananas

Now imagine many such systems working this way, all interacting and influencing each other, you can see why the original rational could get easily lost in the world.

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Yes this is a little bit like the chicken and egg situation.

It is - but that's reflexivity for you.

You believe the theory that over the long term that exchange moves back to 'purchasing power parity'. I'm trying to explain one reason why that may not exist even within a currency - never mind across currencies.

Well, I don't really believe "purchasing power parity" - in so far as It is definitely not what I see in the world around me. I do think that there has to be something beyond a reflexive explanation, however. I don't accept "because it is" as being an explanation that can deceive everyone for very long... we live in a broadly free society - so, at some point, irrational trends will fail and a new 'normal' will be found... even if that, too, is irrational, it will likely have some objective basis - at least initially. Ideas I have for influences that must skew purchasing power parity include transportation; taxation; population demographics; bureaucratic overheads; technical/political innovation; social structure and existing debt.

I think that people must believe that something (other than the availability of credit) makes some people more creditworthy than others. Maybe everything boils down to trust? Maybe the only thing that matters is time since a significant military conflict? Maybe this is what modern terrorists think is wrong with the world - and see their actions as the only way to bring credit into question?

It seems obvious to me that credit expansion can't last forever... particularly not in a 'low inflation' environment (where wages/products don't rise in price anywhere near as fast as credit expands) or where credit expands at a rate above the rate of interest. In the latter case, it seems inevitable that corruption will ensue and that this will cripple any economy - and, eventually, devalue any currency.

Harping back to Soros, he thinks we've been in a super-bubble since 1979 - with roots in the financial infrastructure adopted in the aftermath of WW2 - where a global war had effectively destroyed credit by destroying trust. History certainly seems to support this idea... but this begs a huge question... if the system of international credit established in 1946 at Bretton Woods was flawed - and it has taken about 60 years for the flaws to become so obvious that they can't be swept under the carpet... what will be the likely consequences? Can the flaws be fixed by adoption of regulatory or other checks that eventually result in a comfortable balance? Is unilateral agreement for such an end a pipedream? Will the system, at some point, collapse entirely as a murmur of displeasure at iniquity results in exponentially increasing proportion of the world rejecting a system that has lost credibility? Might there be a new international agreement based upon less arbitrary accounting practices? If Soros' super-bubble is over, what will replace the vacuum that it would leave behind? Would the super-bubble deflate or burst catastrophically?

All of this, as I see it, hangs on exchange rates... I wonder how rational they are... they seem far more stable than I'd expect if there were no tangible basis other than guesswork based upon yesterdays' rates. I wonder if it will all come down to defaults and financial assets... I wonder how credible massive currency rate movements might be - and if the British government today would have the inclination/will to protect the value of Sterling by substantially raising interest rates? Is that even possible today in the context of an independent bank of England? Are central banks around the world trying to establish "purchasing power parity" by the adoption of CPI? Are we likely to see a substantially different monetary policy adopted on a global basis?

Edited by A.steve

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EDIT: to read the full article copy the title and google it. You can then see the article in full. It is worth it. I don't know why this works but it does.

By the way there isn't as far as I know a simple relationship between asset prices and available credit. i.e. if there exists 100 houses, an additional £100 credit does not put £1 on each house. That additional credit may be used to bid up the transactions in the market - 10 transactions per year say by £10 each on average. So that additional £100 has turned into £1,000 of house price equity or 'wealth' which if they are to be maintained at the new elevated level, would require additional credit over the ensuing years.

Good article in the FT - though I found it a little too high-level... and US focused... for what really matters to me. My interpretation of requiring $5 in extra credit for $1 in extra GDP growth is that sustaining growth is extremely inflationary. Of course, however, I don't accept that GDP is much more than an arbitrary metric... I don't believe GDP growth is necessarily good or GDP contraction necessarily bad... I certainly don't see why GDP should be a metric to determine credit limits - at least not in a linear fashion (for example, stating government or consumer debt as a proportion of GDP) - I think they're fundamentally different sorts of quantity. GDP is about total activity - not 'excess' productivity or 'disposable production'... It feels a bit like saying - yeah, manager's mortgages are fine at £250K because he earns £50K gross - failing to establish, first, the outgoing - Tax; NI; Car; Suits; Food; Energy bills - etc. If UK GDP were £1tn and we had zero debt - but every £1 of GDP was critical in order for survival... we should not be creditworthy as a nation. Conversely, if we could survive on £100bn - we might be the most creditworthy country on earth - with £900bn that we could use to pay interest and pay off debts - if we so wished.

I'm intrigued that you say that there isn't a simple relationship between asset prices and available credit. While I don't have any reference, it seems extremely unlikely that there is not. What proportion of house purchases, in the UK, do you think were made using savings net of any income arising from a house sale? If it was 5% on average over the past 5 years, I'd be amazed... I actually think an accurate figure would be negative. If so, the sole determinant of house prices has been credit availability... the maximum loans achievable have set the market prices. I think that under one in ten home buyers think in terms of capital - the rest concern themselves only with cash-flow... and, frequently, I think, even that has been neglected. I'm sure that something similar has happened with commercial property - and the reason (in my opinion) this has not extended to equities is that companies are laden with debts rather than shares being suitable collateral for high LTV loans. Obviously, to keep the game going, exponentially more credit is demanded every year - and, eventually, this is bound to fail... but, until it does - until defaults give rise to losses, ever more credit can be offered and this can support the price of homes - assuming buyers only have extremely short-term vision.

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If Soros' super-bubble is over, what will replace the vacuum that it would leave behind? Would the super-bubble deflate or burst catastrophically?

All of this, as I see it, hangs on exchange rates... I wonder how rational they are... they seem far more stable than I'd expect if there were no tangible basis other than guesswork based upon yesterdays' rates. I wonder if it will all come down to defaults and financial assets... I wonder how credible massive currency rate movements might be - and if the British government today would have the inclination/will to protect the value of Sterling by substantially raising interest rates? Is that even possible today in the context of an independent bank of England? Are central banks around the world trying to establish "purchasing power parity" by the adoption of CPI? Are we likely to see a substantially different monetary policy adopted on a global basis?

Money has a value. the value is obvious to anyone who has ever worked. the value that money has is intrinsically linked to how difficult that money is to come by. while credit was expanding the trend was self reinforcing because people borrowing today to purchase assets had a temporal advantage over people tomorrow. self reinforcing trends stay in place until they undermine themselves. had newton understood markets this would have been his second law!

We stand today at the apogee of a global credit bubble caused by the achilles heel of the new keynesian paradigm. the prosperity that it has bought in the last 50 years has only been borrowed from the next 50.

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We stand today at the apogee of a global credit bubble caused by the achilles heel of the new keynesian paradigm.

Easy for you to say. :rolleyes:

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OK, this is absurdly simplistic, but is not the truth here very simple- there are more or less the same amount of resources now as there were a year ago- it's not like the world has suffered a catastrophic event in reality.

So the problems we now see are artifacts of the financial system itself- specificly the banks went wild with their ability to magic debt from thin air and 'made' too much of it. This excess of debt does not impact on the amount of real world resources available, but what it does do is threaten to decouple financial reality from real reality to such a degree that our ability to function as trading nations is disrupted.

All we need to fix the situation is new and better magic trick. In the real world toxic waste like nuclear is 'parked' deep underground. So why not create a mega SIV to contain all the toxic dept and bury that somewhere for future generations to worry about?

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OK, this is absurdly simplistic, but is not the truth here very simple- there are more or less the same amount of resources now as there were a year ago- it's not like the world has suffered a catastrophic event in reality.

So the problems we now see are artifacts of the financial system itself- specificly the banks went wild with their ability to magic debt from thin air and 'made' too much of it. This excess of debt does not impact on the amount of real world resources available, but what it does do is threaten to decouple financial reality from real reality to such a degree that our ability to function as trading nations is disrupted.

All we need to fix the situation is new and better magic trick. In the real world toxic waste like nuclear is 'parked' deep underground. So why not create a mega SIV to contain all the toxic dept and bury that somewhere for future generations to worry about?

because ultimately the bonds/money created weren't based on nothing, they were based on the mortgages etc.

the basic problem is that many of the mortgages are bad, we KNOW that they are going to default, and once that happens, all of the financial structure that was based on that loan or loans collapses.

it is easy to create new loans to cover those loans in case of failure, we are doing that now with the Central Bank guarantees, but you still have the basic problem that there was too much credit that can't be serviced or covered without the constant creation of new credit to cover the shortfalls.

say you ran up too much credit card debt, that you couldn't possibly repay. You know that you are going to default on a good part of it.

in theory the bank could just keep loaning you more and more to keep covering the shortfall, but each time they do, it inserts more and more interest payments that have to be paid, until you get to the point where just paying the interest on all the layers of credit is more than you make.

ultimately it just crashes and the defaults still happen, but it's even worse because now there is 100 times the credit that ends up being destroyed, as opposed to just having defaulted in the first place.

what it comes down to is that if you have a bill, it has to be paid or someone HAS to take a loss.

you can put off the day of payment by taking out more loans etc, but there is a cost to that as well (interest payments) that ultimately means that there is a limit no matter what you do.

Edited by Mr Nice

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Yes - but the point you're missing is that by issuing new loans or money, it effectively reduces the value of the debts already out there bringing them back into a more affordable state. As you say, the only alternative is default. They would much rather inflate away debts. Of course, this does involve a transfer of value from people with savings to people with loans.

Really guys, all the symptoms you see are explained by the Boom Bust principles in Austrian Economics.

There is nothing strange going on now. we are in a bust.

What was strange were the lengths people went to to sustain the boom. They still want too.

The last thing a government wants is for the bust to take place, as they miss out in the acclaim (votes) they receive for the "success" of their amazing handling of the economy.

To admit there is even the chance of no growth is just not acceptable behaviour in public. It even takes 3 quarters of negative growth just for them to admit the economy is contracting!

for anyone wishing to watch the hour long, very interesting bust phase lecture, here is the link: http://video.google.com/videoplay?docid=-2...rassimir+petrov

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I don't disagree.

I'm just saying that the policy responses you will see are aimed at minimising the pain of the 'bust'...not necessarily to avoid it altogether. And those same policy responses look inflationary.

What they effectively try and do is avoid default and disorderly consequences on the economy...e.g. (try) reduce interest rates making debts more affordable, reduce interest rates to encourage more debt and inflation of the money supply, and finally if these don't work (and as Roubini is recommending) undertake an 'orderly debt reduction' programme.

I think it interesting that a lot of people have a go at Helicopter Ben and his inflationary policies. Remember it was he who on taking office began a path of raising interest rates to curb the excesses he inherited.

trouble is, that the market now controls the interest rates. There appears to be a fresh wave of ALT-A defaults on the way, this may have the effect of reducing the ability of the central banks to reduce the cost of new borrowing, as their only means of afecting the market, without adding to the money supply, is through interest rates.

What worries me is the rhetoric from BOTH parties that they need to get the economy BACK on track. In my view, the economy left the rails in about 2000, and its now about 50 miles away from it. What is happening is the economy IS getting back on track. Trying to steer it a bit may help some, and i agree, to the detriment of others, problem being its the sensible and prudent who will be penalised in general more than the feckless.

Of course, many many individuals are going to get crushed whatever the government tries to do.

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Yes - but the point you're missing is that by issuing new loans or money, it effectively reduces the value of the debts already out there bringing them back into a more affordable state. As you say, the only alternative is default. They would much rather inflate away debts. Of course, this does involve a transfer of value from people with savings to people with loans.

I think that debts can only be inflated away by more lending if credit is treated by the public as synonymous with savings. While house prices were steady and rising, people with mortgages saw little difference between cash and credit (for a fairly good reason) - but, now, with falling house prices and rising costs of debt service, it looks remarkably more likely that a difference will be seen and more debt will not have the desired inflationary effect.

What they effectively try and do is avoid default and disorderly consequences on the economy...e.g. (try) reduce interest rates making debts more affordable, reduce interest rates to encourage more debt and inflation of the money supply, and finally if these don't work (and as Roubini is recommending) undertake an 'orderly debt reduction' programme.

I think it interesting that a lot of people have a go at Helicopter Ben and his inflationary policies. Remember it was he who on taking office began a path of raising interest rates to curb the excesses he inherited.

Roubini seems to be being sensible... and I find your take on Ben interesting too. His helicopter speech seems outrageous - maybe he over-estimated his audience? I did find his cuts to be somewhat outrageous... it felt as if he knew that he was doing the right thing raising rates - then lost his nerve.... perhaps thinking he'd been too aggressive - and was shaken at the possible consequences.

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  • 399 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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