The Voodooest Economics of Them All

If you've successfully managed to keep your breakfast down for this long, don't read this Bloomberg News analysis of the bailout extravaganza. Your lead paragraph:

The U.S. government is prepared to lend more than $7.4 trillion on behalf of American taxpayers, or half the value of everything produced in the nation last year, to rescue the financial system since the credit markets seized up 15 months ago.

Gulp. Ignore the misuse of the word "rescue," and the challengable assertion that you couldn't get credit in August of 2007, and plow ahead into one of the most gruesome tabulations since the Jonestown Massacre (or the Brian Jonestown Massacre, for that matter):

The bailout includes a Fed program to buy as much as $2.4 trillion in short-term notes, called commercial paper, that companies use to pay bills, begun Oct. 27, and $1.4 trillion from the FDIC to guarantee bank-to-bank loans, started Oct. 14. […]

President Franklin D. Roosevelt's New Deal of the 1930s, when almost 10,000 banks failed and there was no mechanism to bolster them with cash, is the only rival to the government's current response. The savings and loan bailout of the 1990s cost $209.5 billion in inflation-adjusted numbers, of which $173 billion came from taxpayers, according to a July 1996 report by the U.S. General Accounting Office.

The 1979 U.S. government bailout of Chrysler consisted of bond guarantees, adjusted for inflation, of $4.2 billion, according to a Heritage Foundation report.

In other words, comparing the other government interventions during our lifetimes to what we've seen in the Late BushCapitalism era is like comparing fleas to an elephant. Well, at least they're being transparent about it!

Bloomberg has requested details of Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit against the central bank Nov. 7 seeking to force disclosure of borrower banks and their collateral.

Collateral is an asset pledged to a lender in the event a loan payment isn't made.

"Some have asked us to reveal the names of the banks that are borrowing, how much they are borrowing, what collateral they are posting," Bernanke said Nov. 18 to the House Financial Services Committee. "We think that's counterproductive."

reason on the bailout here.

Comments

[Warren]

Our economy is a junkie. It only feels good when we inject money into it. We need bigger and bigger injections more and more often just to feel less bad. We're getting close to overdosing.

[Vinny]

Ho. ly. shit.

I apologize for the strife I have stoked among my fellow libertarians. No matter your persuasion, if you are American, we have a common enemy: the Treasury.

[EJM]

The related post at FP's "Passport" also flagged this quote from the story...

The money that's been pledged is equivalent to $24,000 for every man, woman and child in the country. It's nine times what the U.S. has spent so far on wars in Iraq and Afghanistan, according to Congressional Budget Office figures. It could pay off more than half the country's mortgages.

[NJ]

This is beyond surreal. How in the world are we going to pay for all of this.

[Episiarch]

I'm getting the sense that the guys at the top either know this is all just smoke and mirrors, or else they have no idea what is going on at all and are just making shit up.

[nj]

I guess the best way to look at this is that in the long run, we are all dead.

[squarooticus]

No matter your persuasion, if you are American, we have a common enemy: the Treasury.

It should be abundantly clear by now that our common enemy is a currency that governments can print at will. Without that problem, there would be no bailouts because there would be no way to pay for them.

How in the world are we going to pay for all of this.

Inflation. There's no other possible answer. Tax revenues simply cannot get grow enough to pay the debt: the peak of the Laffer curve (resulting largely from capital flight to more friendly jurisdictions) is far to the left of the tax rate that would be required.

If you haven't done so already, come up with a plan *now* to preserve your wealth. If you are on a fixed, dollar-denominated income (such as a pension or Social Security) then you, like my parents, are screwed. Sorry to hear it, but you reap what you sow.

[phalkor]

I guess the best way to look at this is that in the long run, we are all dead.

Won't somebody please think of the children?!?!

I mean, we are all someone's children.

[Comrade Dread]

Welcome to Bush-league communism, bitches.

Please don't have my family shot or sent to Florida, Comrade Bush.

[JW]

Since we're only loaning the money to the banks, I'm going to be charging points to those bitches.

[domoarrigato]

The aggregate balance sheet destruction caused by the crisis (which is really just massive credit deleveraging) can be entirely soaked up by the government using the Feds balance sheet. Is this a terrible situation? Yes. Is it better than letting 60-80 of banks and maybe 20-50% of companies go bust? Probably - yes. At least in the short term (2-10 years).

Nothing will ever get "paid for" because ultimately, private credit will be replaced by government debt, and then inflated away. Lesson? By TIPS.

[Abdul]

"Some have asked us to reveal the names of the banks that are borrowing, how much they are borrowing, what collateral they are posting," Bernanke said Nov. 18 to the House Financial Services Committee. "We think that's counterproductive."

He has a point in that the bailout is supposed to prop up confidence in banks. If people find out certain banks are recieving lots of welfare the bank will lose consumer confidence. Consumbers will get the heebie-jeebies and pull out deposits, short the share price, and then Uncle Sam will look stupid because he just put billions of capital into the bank only to cause its failure instead of preventing it.

[SIV]

they have no idea what is going on at all and are just making shit up

Correct

Both Bernancke and Paulson have admitted as much.
Geithner has been the third person at all their meetings so Obama clearly intends to maintain the continuity of Bushonomics.

Insert Warrenisms here:

[squarooticus]

DOOOOOOOOOOOOM!

[Comrade Dread]

Since we're only loaning the money to the banks, I'm going to be charging points to those bitches.

Personally, I've always wanted to charge my bank some exorbitant late fees.

[domoarrigato]

He has a point in that the bailout is supposed to prop up confidence in banks.

Exactly. In fractional reserve banking the purpose of banks is to create credit. Banks are always and everywhere theoretically insolvent at ALL TIMES even if they are functionally solvent for periods of time. Confidence in banks is ever necessary, and ever foolish.

Bubbles and busts are created by credit - but so is enhanced economic growth. The alternative is narrow banks, high interest rates, zero growth except via technological advances which become ever more difficult to fund.

[SIV]

domo,

If they try to inflate the debt away they won't be able to afford financing any new debt at inflationary rates (or refinancing of the old)

ZIRP forever and a deflationary spiral.

I do suppose World War or a default are still options, but a default would be messy.

DOOOOM

[KenK]

I think we will see a bit of deflation but once (if???) the economy recovers at all we will see raging inflation, the likes of which have never been seen in the USA.

If you aren't on LIFO for inventory valuation I would suggest you get on it. And get ready to use NIFO for pricing.

[domoarrigato]

SIV,

If they try to inflate the debt away they won't be able to afford financing any new debt at inflationary rates (or refinancing of the old)

You would be dead ass right if the market wasn't pricing in deflation for the next 7 years. Right now, the government has to pay 2.13% to borrow for 5 years OR 3% PLUS whatever inflation ends up being. So it's cheaper to borrow "unsecured" (in an inflation sense) than secured (using inflation indexed bonds).

Once the treasury actually starts auctioning debt by the trillion - surely rates will rise, but not nearly as much as they will AFTER inflation kicks in. This situation has occurred because, right now, the treasury is the only borrower that the market believes will actually return the principle with probability of 1 - and there is irrationally high demand for that assurance.

[R C Dean]

In fractional reserve banking the purpose of banks is to create credit. Banks are always and everywhere theoretically insolvent at ALL TIMES even if they are functionally solvent for periods of time.

Depends on how you define insolvent. For banks, deposits in the bank are carried as liabilities (money owed by the bank to depositors), and loans by the bank are carried as assets (money owed to the bank by borrowers).

Fractional reserve banking means a bank can loan out more money than it actually has on deposit, so, from a balance sheet aspect, the bank will have more assets (loans out) than liabilities (money on deposit), and wouldn't be insolvent under that definition.

However, from a liquidity standpoint, the bank can't pay off all of its depositors in current funds/currency/cash, so its technically illiquid (which is another definition of insolvency - the inability to pay your debts as they come due).

[R C Dean]

If you aren't on LIFO for inventory valuation I would suggest you get on it. And get ready to use NIFO for pricing.

I've heard of LIFO (Last In First Out) and FIFO (First In First Out), but not NIFO.

[squarooticus]

I've heard of LIFO (Last In First Out) and FIFO (First In First Out), but not NIFO.

The power of Google commands you:

http://www.answers.com/topic/next-in-first-out-nifo

[J sub D]

"Some have asked us to reveal the names of the banks that are borrowing, how much they are borrowing, what collateral they are posting," Bernanke said Nov. 18 to the House Financial Services Committee. "We think that's counterproductive."

I'm from the government and I'm here to help.
I won't cum in your mouth.
The check is in the mail.

[domoarrigato]

RC Dean,

Technically you are right - there is supposed to be a difference between being illiquid and insolvent. My point is that the only practical difference between the two terms is fragile depositor confidence. The asset side is ALWAYS much less liquid than the liability side, and so any bank can be made illiquid rather easily and - unless a lender of last resort steps in - insolvent a day later.

[Blue]

Oh god, we're fucked.

Maybe a zombie plague will make all this horror go away.

Only the Undead can save us now.

[P Brooks]

Warren-

I'm not sure, anymore, who the junkie is. Is it "the economy" which needs a pop to get through the day, or is it "the doctor government" which needs the power rush of being the salvation of all and sundry?

Fasten your seat belts, and hang on. When this ride finally stops, it won't be pretty.

[Seward]

Can we start talking about free banking now?

[Nigel Watt]

This is just getting hilarious. And you can still find statists all over the country saying "government can save us this time, we promise!"

[GG]

Can we start talking about free banking now?

Yes We Can!

[Tbone]

Won't somebody please think of the children?!?!

I'm thinking of the children who will be hunting us down when they realize the economic legacy we've left them.

[phalkor]

Maybe a zombie plague will make all this horror go away.

Max Brooks has the answer - World War Z.

I for one welcome the zombie invasion as my preferred apocalypse scenario. It may just be the world war we're looking for to solve depression 2.0.

[phalkor]

Tbone, my thoughts exactly. Although I'm still very young so I'm more worried about myself moreso than potential offspring.

Getting rid of every sexual predator, dug dealer, and ne'er-do-well still won't protect the children from this.

[Paul]

Prices will either go up, go down, or stay the same. I'm sure of it.

[Malto Dextrin]

Since we're only loaning the money to the banks, I'm going to be charging points to those bitches.

Unfortunately, JW, you are not loaning the banks the money. The Federal Reserve System is not an agency of the Federal Government. Rather, it is a privately owned cartel of banks, which has been granted the monopoly power to create our currency, and charge us interest on the currency so created.

You are not a creditor of the banks and other big companies borrowing these trillions of dollars, the shareholders of the Federal Reserve System are the creditors and will reap the profits as interest.

However, you as a taxpayer are on the hook for the interest payments, since all money created by the Fed and given to the Treasury (in exchange for Treasury IOUs to the Fed) is considered a loan from the privately owned Fed to the US Treasury.

The private owners of the Federal Reserve are charging us all as taxpayers, interest on the funds used to bail out all of these big banks and corporations. This is all quite legal, according to the charter granted by Congress establishing the Federal Reserve System, back in 1913.

These new debts, $7,400 billion dollars, amount to half of the gross GDP of the US. In your name, Congress and the Administration is incurring this debt, which amounts to half of your annual gross salary. You are responsible for paying back this loan, with interest, to the privately held Federal Reserve banking cartel.

The owners of the cartel, are large banking and financial institutions, such as.....Citigroup, JPMorgan Chase, Goldman Sachs, and several other large domestic and foreign banks and financiers.

If you still believe the Federal Reserve system is an agency of the US government, go study this issue. Find out really how our money is created, and who has this power, and how they profit.

[Paul]

Oh, by the way, I am locked and loaded with the response to the next time some egomaniac in a $2,000 suit from one of these corporations opens his/her mouth:

"Shut the fuck up, you're a civil servant, and I pay your salary with my taxes."

I can't waaaiiiittt...

[P Brooks]

"Shut the fuck up, you're a civil servant, and I pay your salary with my taxes."

That works wonders with the police, doesn't it?

[SugarFree]

Bankers rarely carry nightsticks.

[Other Matt]

I've heard of LIFO (Last In First Out) and FIFO (First In First Out), but not NIFO.

Think fuel prices, except when they're going down, in which case it's more like MEIFO (Most Expensive In, First Out).

[Malto Dextrin]

So, JW, you and me all all the rest of the taxpaying public, are going to pay for these bailouts two ways:

1) Our income taxes pay for some of the interest and principal on the trillions of dollars loaned by the Federal Reserve to the US Treasury.

2) The trillions of new dollars created by the Fed, from thin air, and injected into the economy, will devalue the dollar, and the purchasing power of your paycheck and your savings will decrease accordingly. This is the 'inflation tax', and it hits struggling savers the hardest, since it increases the cost of essentials like food and fuel and housing, without any exemption.

The shareholders of the Federal Reserve System banking cartel, are using thier profits, to buy up large chunks of the US and world economy, at bargain basement prices, since the markets have crashed.

After this wealth transfer, from low, middle and upper class people all over the world, to the owners of the Fed has been completed, the Fed will allow the economy to recover by providing easy money, creating another asset bubble. This bubble will grow until it is time to harvest the crop again in a few decades.

It's the ultimate in 'insider trading', extending over the entire economy.

[I M Ankshus]

Letter to My Bank
>
>
>
> Dear Sirs,
>
> In view of what seems to be happening internationally with
> banks at the moment, I was wondering if you could advise me
> on the following matter:
>
> If one of my checks is returned marked "Insufficient
> Funds," how do I know whether that refers to me or to
> you?
>
> Sincerely,
> I. M. Ankshus

[hardcore]

While we can bitch and moan about this all we want, us libertarians can see through the smoke and mirrors. We know, to some degree, how dangerous these policies are.

So how do we profit from this situation, if we can at all? Certainly, the average american will lose and the average bank exec will win. Lets see if we can find strategies to more than just weather the storm, but come out ahead.

[Paul]

That works wonders with the police, doesn't it?

Absolutely. You'd be amazed at how quickly that nets you some free room and board.

[squarooticus]

So how do we profit from this situation, if we can at all? Certainly, the average american will lose and the average bank exec will win. Lets see if we can find strategies to more than just weather the storm, but come out ahead.

Well, of course any smart person is going to do what they can to defend and enhance their wealth within the limitations imposed by reality... but that doesn't mean that I particularly like profiting off the idiocracy. I would much rather have a free banking system or a gold standard and not have these opportunities, nor the pain nor crime that go along with them.

For a real-world example, I don't look forward to the lean years my parents are going to go through when inflation hits the fan and his portfolio is still in the shitter in real terms. I've given them fair warning, but my father would rather lose 40% of his portfolio in "safe" assets like Ford bonds than move it into "unsafe" assets like gold. /me slaps head.

[Malto Dextrin]

So how do we profit from this situation, if we can at all?

Buy gold and/or silver with whatever savings you have. The US dollar, and all other major currencies, are going to fall in value by are large amount in the next few years.

Please read your history books; hyperinflation is a common phenomenon, just not something that has happend in recent memory to Americans.

You will soon be paying $25 for a latte at Starbucks, and $50 for a loaf of bread. At the same time, gold will be priced at thousands of dollars per ounce.

[domoarrigato]

Malto Dextrin,

After this wealth transfer, from low, middle and upper class people all over the world, to the owners of the Fed has been completed...

So could you expound on this claim a little - it's a doozy. How is the wealth transferred? What form does it take? can you give an example of a buildup of wealth that was created by the banks risklessly "printing money"

The Fed is "owned" by member banks - but their ownership consists entirely of a TINY amount of (nominally) equity shares that never increase in value, cant be traded, and pay a 6% dividend. The Fed makes a lot of money, but this is gievn to the Treasury - this is the mechanics of the "inflation tax."

I think you must be a "gold bug libertarian" Do you work in the gold/numismatic industry at all? These charlatans are always running around like crazy after gold has topped out...

[Jordan]

So how do we profit from this situation, if we can at all? Certainly, the average american will lose and the average bank exec will win. Lets see if we can find strategies to more than just weather the storm, but come out ahead.

I'm investing in copper, lead, and brass...

[squarooticus]

I think you must be a "gold bug libertarian" Do you work in the gold/numismatic industry at all? These charlatans are always running around like crazy after gold has topped out...

Nice ad hominem.

I can't speak for Malto Dextrin, but I am not a gold bug: I didn't get into gold investing until a few years ago, and I intend to get out before it becomes a bad investment again. The key is recognizing that such a day is far off.

It seems more accurate to me to say that you are an "anti-gold" bug, because you are the one with an irrational aversion to gold, even when the current market conditions are precisely those in which gold thrives as an investment.

[squarooticus]

I'm investing in copper, lead, and brass...

QFT, brother! The five precious metals are gold, silver... copper, lead, and brass. Of course, you need a little steel (and possibly aluminum) to go along with that, but very little by comparison. 😉

[Jordan]

QFT, brother! The five precious metals are gold, silver... copper, lead, and brass. Of course, you need a little steel (and possibly aluminum) to go along with that, but very little by comparison. 😉

On a somewhat related note, I ordered an AR-15 yesterday, which will not arrive for 4 months (!!). The price seemed reasonable at the time, but at this rate I'm thinking I'll need a year's salary to pay for it when it finally does arrive.

[Brandybuck]

Contrary to the old curmudgeon Rothbard, fractional reserve banking is not fraudulent! It's only a problem when the government comes in and hampers all of the corrective market mechanisms.

When you deposit money in a bank, and the bank says it will pay you interest, then there is no fraud because you know it will be lent out. If the money wasn't being lent out, it would be *you* paying the bank to warehouse your money. As long as you haven't stipulated on demand withdrawals, there is no fraud if the bank does not carry 100% reserves. Bank runs are bad, and can certainly cause banks to collapse, but they are not proof of fraud. If there was a run on milk at your grocer, so that you could not redeem your milk coupon, is the grocer being fraudulent? No! If the bank does not collapse, then you can still get your money out. Just not today. The bank can borrow from other banks, or it can sell off some assets, or call in its loans, etc.

I used to be a Rothbardian goldstandardist, until I realized that what most people mean by "a gold standard" is inherently statist. The government shouldn't be defining money, they should be getting out of money completely.

[egosumabbas]

Can we please rename the "The Treasury" to "The Black Hole"?

[Malto Dextrin]

Hi Domo:

The wealth transfer....So could you expound on this claim a little - it's a doozy. How is the wealth transferred?

It is a doozy. The wealth is transferred by 'front running' the boom/bust economic cycle. In times of easy money (low interest rates, and easy to obtain loans) the price of assets (stocks, bonds, commodities, real estate) increases in nominal terms. Lots of money put into the economy boosts the price of most everything. Think of what would happen if, just before an auction, each bidder entering the room was handed $1,000 in cash.

When money is made harder to get (increase in interest rates, or stricter requirements to get loans), the rising prices suddenly quit rising, or even start to fall. Speculators and momentum traders, especially those that borrowed money to invest near the top of the market, will have thier loans called in when the markets drop. Collateral securing those loans will be foreclosed upon.

If you are astute enough to sense when the money supply is beginning to tighten, you can sell your appreciated assets for high prices, and wait for the markets to crash, and then buy back the same assets for much less at the bottom of the market, just before the money supply is loosened again.

Since the Federal Reserve is chartered by Congress with the power of controlling key interest rates and also with setting other loan parameters (like margin requirements in the stock market), the people who own the Federal Reserve (indirectly, through ownership of the banks that make up the cartel) don't have to guess when the money supply is going to tighten or loosen: They determine when these events happen, and so can guide the economic cycle to thier advantage. They don't have to guess when trying to time the market. This is the ultimate in insider trading, and it is quite legal.

I think you must be a "gold bug libertarian" Do you work in the gold/numismatic industry at all? These charlatans are always running around like crazy after gold has topped out...

Am am now, I guess. But I wasn't until I started looking into the history of money and banking in the US and in other societies, about a year ago as our economy started to get weird.

There are charlatans in any field, especially when the blowoff phase is reached. I am sure this is evident now in the tech and real estate bubbles, and will be in the coming commodities bubble. But I don't think we are near that phase yet; the value of the dollar has not yet adjusted in response to the huge increase in the quantity of money.

If you don't know how our money is created, and don't understand the basics of our banking system, and its history, you are not well positioned to make good economic decisions. It's that simple.

Make it your job learn about these things. You may be amazed and intrigued by how the system really works.

[domoarrigato]

Nice ad hominem.

Only conditionally. I have a strong dislike for people who profit by manipulating other peoples fear for profit. If the guy comes back and says he doesn't sell gold or collectable coins for a living, I will happily say I don't think he is a charlatan.

you are an "anti-gold" bug, because you are the one with an irrational aversion to gold

I am indeed "anti-gold" for monetary purposes, and I have offerred many critiques of this uniquely libertarian fallacy on these boards. My aversion to gold-as-money is anything but irrational, as I formerly advocated a gold standard, but after years of studying inflation, monetary policy, and fixed income markets I have concluded that it is as arbitrary as fiat currency, and has many innate disadvantages, as have been well documented by Milton Friedman.

It's true that Gold has increased in value, but having observed these cycles before I know what goes on. Whenever there is a panic, the gold speculators run up gold and then sell to retail once the dumb public gets involved. They always take huge fees, and spreads, and invariable use fear to sell their wares. It is, for all intents, a "bubble" in security. I find it extremely unlikely that gold will continue to rise in a deflationary environment when every other commodity on the planet is getting chucked out like week old fish.

[Brandybuck]

Please read your history books; hyperinflation is a common phenomenon, just not something that has happend in recent memory to Americans.

Not just in recent memory, hyperinflation has never happened to Americans. We have had bouts of severe inflation before, but never ever hyperinflation.

I don't think we will ever see hyperfinflation here. It happened in Germany but no one (except a couple of cranks in Austra) knew what caused it. Even if some still don't know what causes it, enough people now know that there would be massive demonstrations to stop it (not just mere sign waving on street corners in by Paulites). It's happening right now in Zimbabwe, but that's because there's a dictator in charge with a death penalty for not using the currency. Neither of those two factors are in play here.

There are more productive strategies we can use to combat Fed and Treasury stupidity than using silly scaremongering about hyperinflation.

[Malto Dextrin]

Domo:

I am in no way in the business of selling gold or collectible coins either for a living or as a hobby.

[domoarrigato]

the people who own the Federal Reserve (indirectly, through ownership of the banks that make up the cartel) don't have to guess when the money supply is going to tighten or loosen: They determine when these events happen, and so can guide the economic cycle to thier advantage. They don't have to guess when trying to time the market. This is the ultimate in insider trading, and it is quite legal.

One example, please.

Am am now, I guess.

So you are a gold bug, or you do sell gold/numismatic items?

Make it your job learn about these things. You may be amazed and intrigued by how the system really works.

Yup - I do it for a living. You've cracked the first layer - but the rest will take a bit longer than a year. There is truth and fallacy in every economic viewpoint - including the beloved Austrian school.

[domoarrigato]

I am in no way in the business of selling gold or collectible coins either for a living or as a hobby.

Then I absolve you of being a charlatan - instead you are merely wrong. 😉

[Malto Dextrin]

Not just in recent memory, hyperinflation has never happened to Americans. We have had bouts of severe inflation before, but never ever hyperinflation.

Hyperinflation occurred in the US during the time of the revolutionary war. The continental congress needed to fund the war, but did not have enough money going in to the conflict, so it authorized the printing of "Continental dollars". Over the course of a few years, hundreds of millions of paper dollars were printed, to the point where they literally became worthless. This is the origin of the phrase "Not worth a Continental."

The framers of the constitution, remembering this, prohibited paper money and required that only gold and silver be used as legal tender, by inserting these principles in the Constitution. These are historical facts, albeit obscure facts. Who actually reads the constitution nowadays, or for that matter, studies history?

[Malto Dextrin]

Then I absolve you of being a charlatan - instead you are merely wrong. 😉

Care to wager on that?
I'll sell to you one ounce of gold, for 800 US dollars, three years from now.

I also hope I'm wrong. 🙂

[Malto Dextin]

I stated it reversed: I give you $$ for gold, 3 years from now.

[domoarrigato]

Care to wager on that?
I'll sell to you one ounce of gold, for 800 US dollars, three years from now...reversed...

gold 3 years forward is trading 870 - so If I wanted to speculate, I'd be able to get a better bid in the market. Why not offer $1000 if you are so confident?

[Shem]

Dude, just outright nationalize the motherfuckers already. It can't possibly be any worse than this.

[domoarrigato]

The framers of the constitution, remembering this, prohibited paper money and required that only gold and silver be used as legal tender, by inserting these principles in the Constitution. These are historical facts, albeit obscure facts. Who actually reads the constitution nowadays, or for that matter, studies history?

While we are studying, lets remember that the austrian school's hated Fed (DOOOOOOM) was created to prevent currency debasement by the congress as well. The Congress essentially abrogated their authority to prevent themselves and their sucessors from getting crazy with the Cheeze Whiz.

[SIV]

Gold going up?

I must have missed the uptick in jewelry and industrial metal demand.

[domoarrigato]

I used to be a Rothbardian goldstandardist, until I realized that what most people mean by "a gold standard" is inherently statist. The government shouldn't be defining money, they should be getting out of money completely.

I went this path as well, and then I researched the wildcat era. Competing money isn't necessarily great either, since it introduces significant complexity and non-transparency into thye economy. It also raises enormous taxation and accounting problems. In the end, I concluded that fiat currency is a terrible solution, only that it's better than all the other alternatives.

[R C Dean]

The Congress essentially abrogated their authority to prevent themselves and their sucessors from getting crazy with the Cheeze Whiz.

Well, they certainly seem to have reclaimed this authority.

[domoarrigato]

Well, they certainly seem to have reclaimed this authority.

They got crazy with the summer sausage (spending/debt/pork/bull market in stupidity) - the cheeze whiz (monetarization of the deficit) is still off limits as of 3:10 today.

[Naga Sadow]

Hmmmm . . . with the inflation sure to come I may have to keep bartending for years! Crap!

[SIV]

Naga,

Japan has been waiting for inflation to save them since 1990.Deflation should be bad for the Mississippi casino business though.

[squarooticus]

I have concluded that it is as arbitrary as fiat currency, and has many innate disadvantages, as have been well documented by Milton Friedman.

I certainly can buy the argument that a gold standard is undesirable, leaving aside the comparison with fiat legal tender for a moment. But please explain to me how free market money is bad. I'd argue that fiat currency is especially bad as it relates to taxation, because income and capital gains taxes don't generally allow you to correct for price inflation in the cost basis (though I'm sure lots of people have gotten away with it over the years!)

From my recollection, I don't believe Rothbard actually advocated a gold standard as such because, while it has some advantages, it has the big drawback of encouraging the government to manipulate the gold market.

[Robbie]

After months of trying to research and make sense of this all I could gather was that the money system is horrendously complex and nearly impossible to figure out. What I have gathered so far is that the Fed prints money and lends it to the Treasury, at interest, and then that is distributed into the economy, causing inflation. The Fed charges interest on this created money. Where does this interest come from, where does it go if the Fed doesn't keep it, and if they do keep it, who specifically is getting it?

Domo, could you explain more fully your first comment at 11:37?

[Naga Sadow]

SIV,

Please refer to Great Depression. I'm hoping an influx of gangsters with a taste for gambling and whoring will keep my casino afloat.

Seriously, I'm told my casino is up for sale right now thanks to Vegas fucking up. On another note, my take has gone from 3k a month to roughly 3200 dollars a month. Apparently people like to gamble, drink, and eat at restaurants still. No complaints so far but I got my fingers crossed it stays that way.

[domoarrigato]

Robbie,

I said: The aggregate balance sheet destruction caused by the crisis (which is really just massive credit deleveraging) can be entirely soaked up by the government using the Feds balance sheet. Is this a terrible situation? Yes. Is it better than letting 60-80 of banks and maybe 20-50% of companies go bust? Probably - yes. At least in the short term (2-10 years).

When a bank goes under like LEH brothers, the assets and liabilities don't just go away. Either the bank gets sold, or broken up and the parts get sold. Someone has to buy them, by issueing stock or debt or something - some other company expands their balance sheet to accomodate those assets. What's more, when credit markets become risk averse, banks lend less than they would otherwise - this means that they leave money on deposit at the Fed in excess of what they have to by regulation (the reserve fraction) They are purposely carrying a smaller balance sheet than they could. If the reserve ratio is 10%, every excess dollar left at the Fed indicates the destruction of $9 of credit in the economy, because the bank could lend that much if they wanted to.

This deleveraging effect snowballs, since unwillingness to take risks results in risky asset price depreciation (housing) which further prompts banks to declilne to lend.

The Fed's role is to try and stop this. It becomes a lender of last resort. It's is like a mother bank that has spawned all the others. Unlike them, it has no reserve fraction, and can in an emergency expand it's balance sheet infinitely by trading currency (which is debt for the central bank) for assets. During normal times, this is treasury debt - it does this for no real reason other than to control the monetary supply - it's not for profit. When things get bad, it buys worse assets, to expand it's balance sheet to fill the gap created by risk averse banks. It's the modern way to stop a bank run. And yes, the money can be destroyed as easily as it gets created.

[domoarrigato]

But please explain to me how free market money is bad.

It's not terrible - it's just not as good as fiat in my opinion. Wildcatting introduces transactional difficulties, and a whole industry of middlemen. It also makes certain types of fraud likely (and a host of inevitable regulation and expensive enforcement to go with it). It's a weak second choice for me.

[Brandybuck]

Hyperinflation occurred in the US during the time of the revolutionary war. The continental congress needed to fund the war, but did not have enough money going in to the conflict, so it authorized the printing of "Continental dollars". Over the course of a few years, hundreds of millions of paper dollars were printed, to the point where they literally became worthless.

You've got a possible contender there. But I don't call it hyperinflation because there were competing currencies people could use. Colonial bills, foreign notes, silver, etc. So while the value of the Congressional Continental plummeted in value, you didn't see people using wheelbarrows full of money just to buy their dinner.

I went this path as well, and then I researched the wildcat era.

Look outside the U.S. The problem with looking at money from the American perspective is that we were so oddball historically. States each had their own banking rules. The landscape was a hodgepodge of conflicting regulations. Pointing to this era as an indictment of free banking is erroneous, as is pointing to it as an example of a gold standard. For a better example, look at Scotland.

Competing money isn't necessarily great either, since it introduces significant complexity and non-transparency into thye economy. It also raises enormous taxation and accounting problems. In the end, I concluded that fiat currency is a terrible solution, only that it's better than all the other alternatives.

The problems you cite were largely solved by the free market. Not so much in the US (because of our monetary weirdness), but elsewhere when there was free banking. Banks will converse on common units of account and clearinghouses will deal with much of the accounting. See Larry White for some discussion of this.

[Robbie]

Domo, how does the buying of these risky assets stop a bank run? It seems that it doesnt really matter how much money there is in the system as long as the value of the money stays relatively stable. The ability for money to change hands seems far more important, and in that sense I can understand why it would be better for the Fed to step in and keep banks lending. What discipline would one learn about this stuff under, econ or accounting or what?

[domoarrigato]

how does the buying of these risky assets stop a bank run?

In a bank run, once it has exhausted it's reserves, the bank has to sell its assets to get cash to pay depositors. Individual depositors fear that there wont be enough for them - that only the first people will get their dough. When the lender of last resort says "I'll lend the bank as much money as they need with their risky assets as collateral" it takes away the incentive to run the bank, because everyone feels they could get their money if they needed to. BTW in my usage, buying assets is ~= lending cash against them as collateral because it amounts to the same thing.

The amount of money matters a lot - up to a certain point. When the Fed injects money into a normal banking system by lowering the rate, it expands the amount of credit in the economy. When banks refuse to lend even when the interest rate is 0, injecting more money has no effect - it just sits on deposit at the Fed and doesn't make it from the banking system to the real economy in the form of loans. You can't make the rate less than 0% - people would just hold paper bills or checks.

Econ, finance, and monetary policy. I was lucky to have a fantastic prof at NYU who specialized in monetary policy, plus work with some amazing economists at various places over the years.

[domoarrigato]

Brandybuck,

I'm sure many problems could be solved by free market. One of the issues of free banking that I can think of off the top is the control of monetary policy. It seems that the system would be inherently pro-cyclical and exacerbate boom and bust cycles. A brief search seems to confirm that this has indeed been the case in many times/places that it has been tried. Even if the Fed gets it wrong sometimes, It's has generally managed to be counter-cyclical.

[domoarrigato]

And let me be clear - I'm no fan of legal tender laws. I would welcome the availability of alternative currencies, even though I think they are probably useless, and that people would probably lose a bunch of money. I probably wouldn't use them though, and would not support abolishing the Fed.

[Paul]

about a year ago as our economy started to get weird.

FWIW, our economy never got weird, in my opinion. Our economy is acting exactly as one would expect... that is, once one knows the information that no one knew, or cared to know five (or so) years ago.

When you have financial institutions leveraging themselves out the wazoo with questionable debt instruments, there's a crash somewhere in the future.... as soon as that information becomes known.

The only thing weird about the economy was that it was working the way it did with so few people caring. But like all schemes, the first person to call in a debt starts the cards-a-tumblin'.

[Malto Dextrin]

And let me be clear - I'm no fan of legal tender laws. I would welcome the availability of alternative currencies, even though I think they are probably useless, and that people would probably lose a bunch of money. I probably wouldn't use them though, and would not support abolishing the Fed.

Repealing the legal tender laws, would in effect abolish the Fed. Existence of alternative forms of money would allow individuals to opt out of paying interest to the Fed by opting to not use its Federal Reserve Notes, every one of which is an interest bearing IOU from the US Treasury, the interst payments being secured through direct taxation of the citizenry. In other words, your labor, is collateral for the owners of the Fed.

Whether you support fiat currency or not, there really is no good reason why the Treasury could not create fiat currency on its own, instead of subcontracting out this function to a private monopoly consortium. Why did the Congress give the exclusive money-making printing press to the Fed, which charges the government interest on the money it creates, instead of instructing the Treasury to print up the fiat currency itself, interest free?

Suppose you had the exclusive legal right to counterfeit money. Would you give this right over to someone else, and then also pay that other person for acquiring that right? What a Tom Sawyer whitewash scheme!

And, yes, the ostensible reason for creating the Federal Reserve System, was to provide stability in the value of the dollar. How has that worked out? Today's dollar buys what about 4 cents would buy, a century ago... a 96% loss in value.

[Ed Kless]

This is tantamount to the repeal of the 13th Amendment. We are now all slaves! Ayn Rand was right on this one.

[Brandybuck]

One of the issues of free banking that I can think of off the top is the control of monetary policy. It seems that the system would be inherently pro-cyclical and exacerbate boom and bust cycles.

There would be no "policy" under free banking, as markets don't have policies. They're just markets.

There would be some cyclical tendencies with free banking, simply because there will still be fractional reserves and thus inflation. But it will be market demand for credit that will drive the inflation, not governmental policy that everyone should own a home or to finance major wars without raising taxes. The other banks in the system will act as checks against those banks who inflate too much. Thus, the boom/busts of free banking will not be as severe as those under a centrally controlled monetary system.

A centrally mandated 100% reserve hard money system would prevent inflation and thus the business cycle, but it requires a government to enforce, and they're the last ones I could ever imagine having the disciple not to muck about with policy.

[Brandybuck]

Why did the Congress give the exclusive money-making printing press to the Fed, which charges the government interest on the money it creates, instead of instructing the Treasury to print up the fiat currency itself, interest free?

Because the Fed was supposed to be more than just a printing house. It was supposed to be a central bank performing central bank functions. Being a central bank is one thing the congress or the Treasury cannot do. That we could get along just fine without a central bank (or a central printing press) is another issue.

p.s. My chief problem with the Federal Reserve is NOT that it is private, but that it's central bank. Too many Paulites bring this up as a complaint. A central bank monopoly is wrong regardless if it's a public, quasi-private or private central bank.

[Malto Dextrin]

Yes. If the Fed was not a government enforced monopoly cartel (via the legal tender laws), it would have to compete with other issuers of currency.

Think of it: Every dollar in your pocket was created out of nothing by the Fed and issued to the Treasury in exchange for interest bearing bonds, payable by the Treasury in those same dollars. The government must tax you to get the money to pay the interest on those bonds, which means that YOU must earn the money to pay the taxes that the Treasury then remits to the Fed as the interest payments on the bonds. A fraction of every dollar you earn is skimmed off by the owners of the Fed and spent as they please, without public accounting of any kind.

YOU are paying this interest on every dollar you earn, until you get rid of it by spending it. The more dollars you earn, the more interest the Fed gets. The dollars in your pocket are units of DEBT, not units of value. The fraction of your taxes that are paid to the Fed as interest, are NOT used to support government services, of whatever kind. These funds go directly to the shareholders of the "Federal" "Reserve" System.

How much of the US GDP do the owners of the Fed skim off every year? Well, what is the interest rate on the Treasury bonds issued to the Fed, and what is the total principal of those bonds?

[domoarrigato]

Repealing the legal tender laws, would in effect abolish the Fed.

Nope. In fact it would probably do nothing. The govt would not be obligated to take taxes in any coin but it's own, so you would still need to use them.

In other words, your labor, is collateral for the owners of the Fed.

Alternate currencies would be no better, except through an intermediate step, unless taxation were completely abolished. This is a blind alley.

there really is no good reason why the Treasury could not create fiat currency on its own, instead of subcontracting out this function to a private monopoly consortium.

Yes there is - to remove the tendency to inflate before elections.

A fraction of every dollar you earn is skimmed off by the owners of the Fed and spent as they please, without public accounting of any kind.

No - it is not... The fed is self funded, but this is a very small amount - a few thousand salaries, maintanence, etc. As I explained before, any excess over operating costs is returned to the treasury except for the 6% on the equity shares (which is tiny).

[Malto Dextrin]

No - it is not... The fed is self funded, but this is a very small amount - a few thousand salaries, maintanence, etc. As I explained before, any excess over operating costs is returned to the treasury except for the 6% on the equity shares (which is tiny).

Are the books of the Fed open to public scrutiny, to verify where the money goes? Are these books audited by an independent party?

Alternate currencies would be no better, except through an intermediate step, unless taxation were completely abolished. This is a blind alley.

Taxation need not be abolished, just taxation payable only in Federal Reserve Notes. And even if taxes were still to be paid only in such notes, demand for them would be much less, since most transactions would take place in competing currencies.

Yes there is - to remove the tendency to inflate before elections.

Congressional elections are every two years. We have had plenty of inflation over the decades, irrespective of the election cycle, and under the current currency regime. We have also had one depression and several recessions, and are working on another. Clearly, if the reason for creating the present system was to establish stable currency and stop the business cycle, it has not worked.

[Brandybuck]

Every dollar in your pocket was created out of nothing by the Fed

Actually, those pieces of paper were created by the Treasury. You can take a tour and actually see those little pieces of paper being printed. Cash constitutes such a small percentage of the money supply that the Fed doesn't bother printing it. They have far more efficient ways of inflating.

[Malto Dextrin]

Yes, I know, Brandybuck. But it's hard to visualize a nonmaterial entity like a unit of currency, without seeing in your mind's eye a dollar bill. "They have far more efficient ways of inflating." Unfortunately true.

The headlines today scream that the Fed has committed to a new, $7.4 trillion-with-a-T bailout package. According to the St. Louis Fed, the current monetary base is $1.5 trillion, up from a longtime level of $0.85 trillion last September. If this new $7.4T bailout adds to the monetary base, it will bring it to a new level of $8.9 trillion, a 10-fold increase in the money supply. As this new money works its way from banks into the general economy, we should see a proportional increase in prices.

[domoarrigato]

Are the books of the Fed open to public scrutiny, to verify where the money goes? Are these books audited by an independent party?

the fed publishes a variety of statistics which would answer your questions if you knew how to read them.

Taxation need not be abolished, just taxation payable only in Federal Reserve Notes.

This goes much further than repealing legal tender laws. Why should the government accept other forms of payment, even if other types of moeny are legal. A treasury note is a claim on future tax revenue, so why should the treasury accept Bob Dollars?

Clearly, if the reason for creating the present system was to establish stable currency and stop the business cycle, it has not worked.

Actually recessions have been far fewer, shorter, and shallower since the Fed was created.

In the end, this empirical argument is probably the best one for the Fed. It is inherently unsatisfying to people like you and I, who want to understand why. I have taken the approach of accepting the empirical evidence, and trying to learn why theory should produce what we see in practice.

[domoarrigato]

And yes, the fed gets audited regularly by both the GAO, and private accounting firms.

[Malto Dextrin]

Actually recessions have been far fewer, shorter, and shallower since the Fed was created. In the end, this empirical argument is probably the best one for the Fed. It is inherently unsatisfying to people like you and I, who want to understand why. I have taken the approach of accepting the empirical evidence, and trying to learn why theory should produce what we see in practice.

I'm not convinced that, since 1914, recessions have been fewer, shorter and shallower, when compared to the previous 120 years. Prices were certainly much more stable in the pre-Fed period, and I don't think there was anything like the Great Depression between 1789 and 1914.

And if the adoption of the present system has truly reduced the number and severity of recessions (forgetting about the Depression), it may be that we have merely traded many moderate recessions, for fewer really catastrophic financial crises happening less often.

The US GDP is about $14T. The Fed is going to raise the monetary base from $0.85T to $8.9T over about 6 months, starting last September. It seems to me, that what is going on is the reduction of debt by massive devaluing of the dollar. Apart from issues of economic justice (stealing value from creditors), is the issue of practicality: Can this be pulled off without crashing the economic system? Will the present bondholders sit still while the value of their investment is cut tenfold, or will they dump their bonds and by doing so disrupt trade and commerce? Will savers (those chumps!) get mad enough to ignite civil unrest? Who will take care of the people who trusted the government to make good on its long term commitments, like Social Security?

Tell me where I'm wrong here. How can the creation of all this new money, not have these effects, good (retiring our massive debt) and bad (committing massive fraud against bondholders and others who were promised value from the government in the future)?

[Robbie]

Malto, the reason I don't think putting that much money into the system won't have such inflationary effects is that I don't think it is truly entering the system. Unless I'm wrong, the majority of that is loans to banks which, when paid back, destroys the loaned money and removes it from the system.