Sunday, January 4, 2009

We’re in uncharted territory folks

Uh Oh..... Monetary Flat Spin

Q: Can a central bank reverse deflation by printing money?

Posted by gardeniadotnet @ 02:18 AM (1693 views)
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16 thoughts on “We’re in uncharted territory folks

  • stillthinking says:

    Fantastic find gardeiadotnet.
    The US cannot force their bad debts out into the open and allow defaults, because their debt is held by the Chinese(amongst others), and as that Chinese official so pithily opined, “if the Americans default, the global financial system ends”. I am guessing he didnt mean this in a friendly way.
    Bang on though. The problem has always been the savers, excessive debts being the same as excessive savers. Which is why the central bank hoardings of Asian countries, their foreign reserves, are such a killer.
    I kind of take his point, as I understand the article, he is pointing out that we have demand collapse deflation, not monetary deflation. Although without the fiscal stimulus of various governments including the UK this would lead to monetary deflation.
    But I dont see the “GDP per dollar of debt” chart as a line which intersects with 0% growth per dollar debt. The line should be like a half life curve, always approaching but never actually reaching 0% growth.

    He is suggesting that articially increasing savings/debt does not increase consumption because in actual fact, printing money does not truly make anybody richer(overall), so there is no point switching from a savings strategy.
    Or to put it another way, if I have 100 pounds in the bank and I am worried about my future so I am not spending, should the government print money and distribute this money evenly, in such a way that I now have 200 pounds in the bank, because each pound is only worth half its former value, my net worth has not changed, I am still worried about my future and I am still not going to spend, and demand is still collapsed.
    BUT !
    Government printing/debt/fiscal stimulus etc is -NOT- distributed evenly, and by devaluing the value of my 100 pounds without giving me any of the stimulus, in effect they can appropriate and spend the real value of my savings on my behalf. However, if I anticipate this I might try to abandon ship and cause a collapse in value of say, sterling, for example(!).
    A kind of you spend your savings, or we will spend them for you strategy. Which ignores the fact that pretty much everything we, in the UK buy, coming from abroad, immediately moves the money into the frozen morass of foreign reserves. Our trade imbalance being a kind of in-built demand collapser.

    So printing money cannot stop demand collapse deflation, but it can stop monetary deflation.

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  • mountain goat says:

    @Stillthinking – as long as you keep saying that “savers are the problem” I feel obliged to contradict you. Every financial crisis has at its heart someone or something that can’t pay their debts. That is the problem and the fear it causes. To say the velocity of money is now slowing because of savers is like saying the bucket is leaking because the water level is dropping. We have a debt crisis. There are two ways out. 1. massive default and bankruptcy 2. pay off debt and increase savings levels. People, business’ and banks will only start spending again when fear of bankruptcies eases. Why lend or even pay for a service if you fear that the other party may be bankrupt soon or that you may lose your job soon?

    Also this money velocity drop is based on conventional statistics. If you included unconvential spending like the Trillions of Treasuries bought in the past few months velocity would still be high. There is a huge amount of liquidity sloshing about it is just hiding in Treasuries. To ignore this and start screaming “deflation” is wrong. We are in a crisis and so money is not flowing as it usually does, but to say money supply is disappearing is just not true since there is the biggest Treasuries bubble in history at the moment. As soon as fear of insolvencies eases this liquidity will gush out causing hyper-inflation. I am sure Central Bankers are already thinking of solutions for this. It might be disorderly as in much higher oil, gold and commodities prices or done systematically against a basket of currencies and commodities.

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  • mark wadsworth says:

    That is a fascinating find and a good summary.

    I like the way that it’s not just me that says that money is just one specific form of credit (of which ‘debt’ is the flipside, obviously).

    Credit is a function of people’s confidence in the economy overall and more specifically, the confidence that a lender has that the borrower will be able to repay. Merely tinkering with money supply and interest rates can’t possibly have any impact on this – and if I understand the article correctly, if overall confidence is low enough, excessive tinkering serves to erode confidence even further, so $1 of ‘bad’ credit (i.e. a number on a bit of paper) drives out more than $1 of ‘good’ credit (a measure of people’s confidence).

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  • stillthinking says:

    mountain goat,

    You can’t pay off debt -and- increase savings. The two are equivalent. One person’s savings is anothers debt. The only way to reduce the current level of debt is to reduce the current level of savings. In other words, to reduce debt savers must buy something off the debtors, in so doing allowing them to reduce the amount owed.
    I don’t see this as necessarily the responsibility of UK savers, I consider the foreign reserves of sterling to be the main problem. Essentially China and Japan are UK savers who never buy anything. Or even the rich members of the banking community, who need to spend their winnings (trying to strike a popular note..).

    But my key response to your post is that debt and savings are the opposite side of the same coin. Imagine the extreme situation where there is no debt, and everybody has savings. What exactly would back those savings up? Just blind faith. Where would those savings have originally come from? If not from debt, then must have come purely from the printing press.

    Debt underpins savings. If you want debtors to be able to repay their loans, then they must ultimately work off their debts to the savers.

    i.e. The savers must spend. If they don’t then there is no demand and the economy collapses. Imagine further, if you will, a society where all income is saved. Where would the jobs come from? Nobody would be buying anything !

    I do agree that the money supply is not decreasing, except as the linked article points out, the velocity, or the multiplier effect, based on how quickly transactions are made, is causing a collapse in the puffed up appearance of the money supply.

    What I consider this article to suggest, is that printing money does not increase demand -but- it is based on false premise that the printed money is distributed equally, so nobody is richer and demand does not increase. My point is that the printed money would not be distributed evenly, and would in effect be a transfer mechanism of real wealth away from savers. Say this transferred real wealth creates a job for some unemployed person. Suddenly that person has money and demand is created. My issue with the government is that they are not using this transferred wealth in a sustainable way through public projects, which apart from being slow to start, also finish. They should allow the size of the sustainable private sector to increase.
    Also, it is unfair to savers. Absolutely agree. We should never have allowed such large foreign sterling reserves to be built up, or put it another way we were fools to let the size of the trade deficit balloon to the current level.

    Basically, I disagree with your post at this point “2. pay off debt and increase savings levels” on the grounds that it is -impossible- in our debt based money system..

    However, I do take your point that saying that savers are the problem is a bit unfair, because I could also, and probably should say that debtors are the problem. The government, being a major debtor, would accordingly be most guilty. The two being equivalent, I don’t care either way. I do, admittedly, recently use savers which is a bit unfair, as they were just prudent.
    Mea culpa. From now on I blame the debtors.

    However (again however..), only the savers can choose to spend now. The debtors admittedly had the choice not to borrow, and I wish they hadn’t, but that time is gone. The economic ball is now firmly in the saver’s court. I wish sincerely that foreign reserves could come flooding back as a result of foreign demand for British goods. Obviously that isn’t happening. That only leaves pressure on one point, the domestic UK saver.

    Given that the banks cannot honour their obligations, there is now a choice of bankrupted banks removing say 30% of savings by just disappearing. Or all savings remaining but losing 30% of their value. Not much of a choice.

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  • mountain goat says:

    @Stillthinking – thanks for your explanation. I think we are getting closer to the difference in views we hold. In mine, money saved represents wealth created, like diamonds or berries that were randomly scattered in nature but now through my labour, collected and ready for human use. Storing the wealth means it can be used in investment or spent for other goods and services. In your view money saved is a private stash of a finite resource that exists in human society. So if I have a lot of savings then someone must have less, or be in debt.

    So with my view, being in debt is making claim to wealth you have not earned yet. It is not theft because you entered into a contract to pay the lender back. But still you have not earned it through your labours. Savers and borrowers are not equal, the saver has earned his wealth through labour. So I do not see them as different sides of the same coin. Without savings, wealth created through labour, there would be no wealth at all, the money in circulation would not be worth more than the paper itself.

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  • This question (Can a central bank….) has been going round in my mind for some while now.

    Thanks for the post and comments.

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  • stillthinking says:

    A diamond based money system would allow us all to be savers, or a gold based money system, again we can all be savers. That system was abandoned though.

    For me the unfairness is that the savings which need to disappear cannot be accurately targeted. Consider this idea. There is no bank intermediary. You are thinking about selling a small one bedroom flat at the height of the housing boom to a Mr.P. Ratt. He agrees to pay you back the capital plus any compensation for inflation, irrespective of the level of inflation. Mr. Ratt has a low level job and has offered you 10x his salary.

    On your own you might consider that Mr.Ratt has no way in hell of fulfilling the deal and so decline.
    But with the bank as intermediary you accept. But Mr.Ratt has no way in hell of fulfilling the deal to the bank. Hence the savings problem. Some savings are not going to be honoured by the debt that created them.
    You might think from that to define debt in terms of how it has been earnt.
    a) Bank bonus savings from a fake boom. You might not consider this worth the guarantee of the taxpayer. Let them disappear.
    b) Profits from selling your house to somebody who can’t afford it. Tricky because it involved a gamble on behalf of the seller about prices. You decide this one.
    c) Savings from 40 years working in a factory.Definitely worth the taxpayer guarantee.

    But all these savings are jumbled up. You can’t target which savings disappear. The obvious (now it seems obvious anyway), was that if the house price boom and the debt bubble were unsustainable, then you would need to remove wealth from sterling before anybody else realised. Now everybody has. This is enormously unfair to c) and also only because he worked in the private sector, public sector “savings” being inflation safe.

    While it is true that there is a deflationary environment now, don’t be fooled. There will be a huge rush of inflation at some point in the future. It is part and parcel of the economic recovery.

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  • mountain goat says:

    Interesting read in the WSJ on hard and soft money.

    “The times were hard in the 1870s and, for that matter, again in the 1890s, but Americans repeatedly spurned the Populist cries for a dollar you didn’t have to dig out of the ground but could rather print up by the job lot. “If the Government can create money,” as a hard-money propagandist put it in an 1892 broadside entitled “Cheap Money,” “why should not it create all that everybody wants? Why should anybody work for a living?” And — in a most prescient rhetorical question — he went on to ask, “Why should we have any limit put to the volume of our currency?”
    A couple of panics later, the Federal Reserve came along — the year was 1913….”

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  • yes default is the answer. Default and yes a relatively quick pain, where the remaining businesses become leaner and sharper. Companies have to go under because if they dont the default just gets spread so you have a contraction anyway. I think in his heart of heart GB plus all politicians know this. The question is how long can they put off the day of reckoning? Thats a political and not an economic decision. Whats happening in the US gives us the map of who this will probably pan out. We – both sides of the pond – have more pain to go through. The point is that since the US is in front it will come out of the depression first. When? Not for quite some “time” or quite some downward momentum in the markets. The 2 arent mutually exclusive.

    I actually feel a bit sorry for obama – really anyone that knows should not have taken on this at this time. I think he is a good bloke (although how would i know) and i think its a great time for the republicans for them to lose power. I think Obama may well be villified and actually durting his presidency may find that whatever he does doesnt work. How will that manifest? Well i think this will end in somthing tragic. Ill advised obama.

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  • stillthinking says:

    “Broken arrow” . Indeed techieman !

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  • Savings, pension pots, stocks,(+ houses, of course) – all part of the same interdependent monetary system. Like the house owners now resisting the need to face the re-pricing of their asset, those possessing the aforementioned, are screeching ‘it’s not fair – I’ve been good’.
    Let’s face it, the move away from old style ‘public'(bad) to ‘private’ (good) ownership of utilities and anything else that wasn’t nailed down, has resulted in lots of ‘money’ sloshing around trying to find a home – with the resultant inflationary aftertaste lingering on decades later.
    Remember the pensions Mrs T awarded her loyal police force (for instance) – the protests from actuaries were there, but muffled by the loyal fourth estate (market forces….have some Murdoch, hehehehehe).
    Now, the reality is that everyone outside the bombproof civil servants has had their worth repriced by bigger sticks fishes in the pond – the cruelty that destroyed the hopes of say, poor but educated FTB’s (lacking the resources of Bank Mummy and Daddy), is being visited upon many who thought they were immune.
    In many respects I welcome this, it’s time for many more people to feel the thwack of the ‘free-market’ bat on their metaphorical arses, and maybe we can all rediscover the meaning of words like ‘community’, ‘justice’, ‘fairness’.
    What are the chances of getting stuff like those pensions, PPFI, tax ‘avoidance’ brought under the umbrella of those old fashioned words – well I wouldn’t hold my breath.

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  • If I can just throw something in the ring about Obama.

    not sure if you’ve heard me say this before but historically speaking Obama was one of the most vocal on repealing the Communities Reinvestment Act 1977, which paved the way for more lending to subprime mortgagees through his involvement in ACORN.

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  • stillthinking says:

    Obama doesn’t control American fiscal policy. America is dependant on dollars being continuously soaked up and frozen. Mountain Goats link is a humourously put “the coming collapse of the dollar” article(nice).
    But the dollar hasn’t collapsed. I sometimes wonder whether the reason why the gold rampers are so frothy around the mouth (really keen enthusiastic posters) is because actually, they are right, the world cannot use their savings without chronic inflation in the western world but still nobody is spending. You can imagine a heavily sedated gold bug ranting away in some loony bin, “I am rich! I am rich !”.
    But unfortunately everybody else is too stupid too realise. The tragedy of the gold hoarder. One day maybe.
    America is in some kind of horrible fiscal death dance with her creditor nation trading partners. But still, there is the dollar hanging on in there. Where is the pound?

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  • “America is in some kind of horrible fiscal death dance with her creditor nation trading partners.”

    Really couldn’t have put it better.

    Have we got the the bottom of whether default is really an option?

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  • mountain goat says:

    @Stillthinking – “gold rampers are so frothy around the mouth”.

    Things have been quite quiet lately on here from gold bugs, in fact gold being dismissed is all I read on this site these days even tho gold is at a record high against GBP. Where does the hot money go when the Treasuries bubble gets sold off? Anyway we all make our choices …

    Back to the article I quoted, I think the main points I found interesting was that all the warnings about the dangers of soft money have come to pass, but the benefits (no more depressions) are still with us.

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  • stillthinking says:

    Come to think of it, you are right mountain goat. There haven’t been any for a while. I remember s2r1 was very keen, although I could never stomach that Mayan calendar stuff. I like fiat money myself, because the problem with hard money is that it all ends up in a few hands, then you get born into a system where you can’t get any.
    Maybe there are always financial problems. We all try to get by I suppose.

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