Monday, December 15, 2008

Money creation finally here

Why You Must Immediately Bet on Inflation

Last week, the Fed took a "quantum leap," according to George Goncalves, the chief Treasury and agency strategist at Morgan Stanley. Instead of swapping assets in the banking system, the Fed started buying them. The Fed bought $5 billion of Freddie Mac, Fannie Mae, and Federal Home Loan Bank corporate debt. The New York Fed's website says the purchases are being "financed through the creation of additional bank reserves." The Fed has finally started to create money out of thin air. The market didn't flip out. And the strategy worked. The average rate on a 30-year fixed-rate mortgage fell from 5.97% to 5.53%... the largest weekly drop in 27 years. Now that the Fed sees how successful this strategy was, we can expect the government to continue with it.

Posted by sold 2 rent 1 @ 02:04 PM (2278 views)
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27 thoughts on “Money creation finally here

  • This is a bit counter-intuitive though, why would the average rate drop after money printing? The only explanation I can make up is that;

    new rate = old rate – lower default risk + higher inflation

    Or that the lessening of the costs of default are, at the moment, more than the costs through inflation. So effectively they are lowering the costs of default for lenders. But if that is the case ultimately the higher inflation will outweigh the lessened costs of default, and then interest rates will rise.
    But even if you follow inflationary policies, if the economy is suffered from a demand collapse, then you still won’t be able to increase prices. In which case the inflationary surge is being delayed. And in that case buying gold is a good idea. But to accept that means that you also accept that the US government has been successful in fighting off a deflationary episode, but they haven’t been because prices are still falling.
    I can’t draw any useful conclusion from this, but great post. Probably I am wrong about holding gold. But I still think if you ultimate goal is to buy a house then just wait until house prices stop dropping, its a very slow process, if you are reading this you won’t miss the bottom, and then why bother with the intermediate step of money->gold->money. If you already have a house then perhaps gold is good.
    Lets hope New Labour don’t confiscate eh? They have the names and addresses of everybody who bought more than 10K in a year.

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  • It’s not inflationary yet because there is a huge bad-debt hole making a very loud sucking sound!

    As to gold, i think it also functions in deflation because deflation leads to default and threats to fiat currency. We might see USD collapse, increased commodity deflation but gold appreciation (as we have seen for gold priced in GBP).

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  • last_days_of_disco says:

    I think the reality of deflation is so big people don’t grasp it. We don’t realize that we are now just being hit by last year’s write downs and those are going to trigger further credit write downs. The thing is, the effects come in waves, so just when you think you have turned the corner, you get hit by another wave of deflation that was created about a year ago. Its very hard for people to track these waves as they move through the system, so its really difficult to set policy once the majority start freaking out and demanding policy decisions from politicians which are already out of date because the next wave is about to hit.

    You don’t see *anyone* explaining to Joe public why you get these waves of deflation and where their source is. How is it then possible in a democracy for the majority to make the right policy decision? If the public gets their hands on the policy making process, they will crash the plane, its as simple as that, because they haven’t got the info they need to make the right decision. The question I have is: Do the experts understand? They seem to be so bound by their particular doctrines, they are unable to think outside the box and solve the real problems.

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  • stillthinking,

    “if you are reading this you won’t miss the bottom, and then why bother with the intermediate step of money->gold->money”.

    You have 1 asumption that I disagree with, that fiat currencies will still exist in 2-3 years time.

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  • Well, that is just one assumption I suppose, but a pretty major one s2r1. ldo_disco, I think deflation is huge also, but irrespective of how huge deflation is, printing money cannot move interest rates down. The change in rates was a reaction to the news in a short time span, overall certainly rates are falling due to deflation, but this fall in rates was triggered by printing. Which doesn’t make sense even within a backdrop of falling rates.

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  • S2R1:
    once again… if you really do think there will be no currencies in 2-3 years [fiat or not], then what use will that gold be until there is a currency again [fiat or not]? Wouldn’t it make more sense to buy whisky, dried milk, tinned food, guns, ammo, etc… – things that will be liquid commodities during that period?
    OR have you already done this and still have plenty of capital left over which you need to store for the entire period?
    OR do you think gold will be liquid?
    OR something else?

    [ I personally don’t think that we face the end of fiat currency, but that there are fair chances of high inflation in the medium term (2-5 years) and that if we did reach the end of fiat currency then gold would go up in value, but it won’t be liquid and would hence only be useful as a store of wealth in the ultra-long-term. ]

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  • @6 I have asked this question many times myself without ever receiving a satisfactory response

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  • 51ck-6-51x,

    I have already purchased a load of tinned food and powered milk.
    I plan to exit a large part of my gold holdings when gold peaks in spring 2010 and buy a property during that summer/autumn

    Just because Western Capitalism falls it doesn’t mean we have total anarchy.
    Gardenia’s food production techniques will allow us not to go hungry IF we work together – can’t you see LDOD’s stable global system here.

    As for the remaining gold, I will keep it for when the real power of gold is revealed to the masses, its monatomic form.

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  • japanese uncle says:

    Wealth is shifted in hundreds of billions, generally from the poor thus less informed to the rich, thus better informed/more agile during the formation and collapse of assets bubbles. Such wealth now obviously in safer forms such as cash deposits, government bonds, or maybe gold, etc. are least likely to be channeled back into circulation, for the purpose of consumption. Unless they go mad and start spending hugely, e.g. Bill Gates starting to eat three dozens of hamburgers every day, buying hundreds of expensive suits a day, and a dozens of luxurious mansions every week indeed, their assets will remain dormant. On the other hand, those who have lost fortune through the collapse of the bubble, or those who had nothing to do with the bubble any way but on the receiving end of the impact of the collapse (job loss, etc), will start spending less and less. Credit squeeze as an inevitable aftermath of the collapse of bubbles, will also play a significant role in this process in an economy like the UK/US. Money in circulation will dwindle much faster than the reduction of supply of goods and services. It’s all inevitable. Deflation is the only course of event available to us, unless the legislation is introduced by which the wealth seized from the rich by heavily progressive taxation is redistributed to the poor who will instantly start spending. Of course those greedy and powerful rich will never allow governments under their control to do that.

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  • last_days_of_disco says:

    Rates are irrelevant. They mean almost nothing when you are facing loss of your asset. So what if the 30 year rate is 5%? If you are in danger of losing 50% of your wealth you are looking for safety, not a return. That is why T bills are making a loss and people are still piling in. Sheer terror.

    Leveraging is the problem, not rates. Rates fine tune the system. Leverage is the coarse adjustment knob. People are being to be much more careful who they lend money to. In fact no one really wants to lend money to anyone but the most reliable borrowers. This all makes sense. Our crack fueled economy is now re-adjusting to reality and overshooting in the direction of caution, again totally understandable. The problem is the majority and the political elites who serve them are going to do their best to reverse this prudent trend.

    People are looking at everything with a careful scrutiny which is showing up the loads of dud assets that were being sold as prime assets.

    Getting to the problem of printing money. There are global political limits. Unless the US is willing to nuke countries and stuff there is only so much repudiation they can do via the printing press. China is quite happy to be holding onto physical dollars. The Americans are going to have to be willing to fight a war with them if they want to devalue their currency. That would be the more costly option, not that that ever prevented wars.

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  • “Just because Western Capitalism falls it doesn’t mean we have total anarchy” that is one big fckin assumption s2r1 but then having read this site for a few months I guess its not even closest to your biggest. You tinned up any sense of doubt along with those peaches?

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  • And also s2r1 how you going to “buy” land, what system of ownership exists then.

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  • how can deflation stays when GBP is collapsing? surely that means that importing good will be more expensive – and in a country with a negative commercial balance, it means it pushes price up.

    look at the price of an Apple iMac on http://www.apple.com/uk: GBP1,400 which is about EUR1,500. Now have a look on http://www.apple.fr or ES, DE, IT etc… it’s around EUR2,000.
    What is going to happen next? Prices in UK going up? or staying the same, but the GBP decreasing – prices in EUR going up? (doesn’t seem likely)

    if someone could shed some light here….

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  • bellwether,

    Sure I could be wrong on many things, but one thing is certain, that life will change beyond recognition in the next 2-3 years.
    Hoping that things are not “that bad” isn’t much of a plan either.

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  • Saw an interesting explanation recently of how hyperinflation starts – with shortages of essential goods in the shops.

    This could be caused by firms going bust, firms failing to get loan approval to allow ships to sail, or be unloaded, foreign suppliers not wanting to be paid in sterling, suppliers not trusting to be paid in 30 days time because shop may have gone bust in the meantime (Woolworths…) – whatever.

    When some (essential) goods do eventually arrive in the shops foolowing the shortage – people buy more than they need immediately to have some ‘in stock’ in case shortages happen again. This creates a further shortage. It’s not hard to see how this can feed on itself and create wild swings in availability of stuff – now you see it, now you don’t.

    Then, when a shop gets some stock of a shortage item – they charge more than they did before because it is in short supply – and people pay up – and still stock up.

    This then feeds on itself after a few repetitions because people realise that the next time they see things in the shop, they will cost more, so they stock up even more.

    Then people demand more wages to cope with getting supplies of essential food/goods. Firms pay this because they are making more money because they are able to charge more (or the Government does all it can to help hard working families get through this ‘Global’ problem).

    And so on…

    Even when demand for cars/plasma TVs/bling is falling – creating more firms going bust, further knocking the confidence of overseas suppliers in UK PLC and sterling.

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  • Frenchie you are right that a depreciating currency makes goods expensive but in a deflation spiral people lose jobs and buy less. This means the prices of basic goods and food fall. The raw materials and labour costs of manufacturing iPhones will fall but they might actually get more expensive as less are produced so the economy of scale is lost.

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  • frenchie, the Europeans will just buy them from apple.co.uk and save 550 Euros

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  • japanese uncle says:

    Frenchie

    People will shift from silk neckties to polyester ties whereby nominal price of neckties can remain the same or cheaper. Quality of goods and services cannot help being safcrificed in this climate. Also as mountain goat says, wages and profits will have to be heavily squeezed, to make up for this deterioration in terms of trade. Thus overall standard of living will be considerablly worse off.

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  • Interesting article on Market Oracle on the relationship between Deflation and Hyperinflation. Apparently the Weimar Republic suffered a deflationary collapse causing the gov to print money in a panic which eventually led to hyperinflation. We have to hope our current Central Bankers have studied history and have inventive methods at the ready when their quantitative easing needs to be turned around to prevent hyperinflation.

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  • last_days_of_disco says:

    @mountain goat

    If this happens America is over, a world changing event. It will be shocking to see them disband their armies and go home. Although we know what that feels like.

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  • LDOD,

    “If this happens America is over, a world changing event. It will be shocking to see them disband their armies and go home. Although we know what that feels like.”

    Pencil this event in for autumn 2010 – end of the sixth night (maps to communism falling in 1985-1991)

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  • last_days_of_disco says:

    @sold 2 rent 1

    You know I work only based on facts, not meta-physics. (And I don’t believe in chemtrails either 😉 ). You may have found a pattern, but the rest is meta-physics, similar to, “the earth is attracted to the sun because they love each other”. Sounds plausible, but is completely unprovable.

    Too many years chasing my tail doing research getting to grips with how easy it is to see patterns where there are none. Proving stuff right is impossible, you can only prove things wrong (scientifically speaking).

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  • LDOD,

    But what makes the system stable at the global level if there isn’t some cosmic plan.

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  • Mountain Goat – good article on the German hyper-inflation. However, I wonder if things are quite the same here as in Germany in 1920 – then most ordinary people would have had small cash reserves, which were to buy what they needed for the near future – once they feared that the value of the cash might be suspect, the natural thing was to go out and get the things they needed. As prices rose, this proved their fears, so they spent as soon as they received their pay and so it spiralled upwards. These days, few people have cash reserves and most buy on credit, so the recent damage to the banks and their reluctance to extend further credit will act, to some extent, as a brake. Maybe…

    Personally I favour the collapsing supply chain theory, that goods will be in short supply just as the extra cash being printed finally finds its way into the system. But I’m interested to read other comments on this.

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  • 15. cornishman

    Exactly my thoughts. Hyperinflation is a very likely scenario. I am not convinced that deflation is here to stay. A momentary rest bite.

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  • 23. sold 2 rent 1

    I FOUND THAT VERY FUNNY!!
    I CAN’T THINK WHY. LOL.

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  • 7. theboltonfury said…
    @6 I have asked this question many times myself without ever receiving a satisfactory response

    crunchy: You can inflate money without a wheel barrow if you have a cashless system. You can also track every penny that moves.
    Well worth some thought.

    Another possibility is to reduce global currencies down to 2 or 3.

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