U.S. Economy Risks Dire Prospect of Hyperinflation

[raja]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

Would a partial 'forgiveness' of debt directed at the general public (student loans, equity loans, car loans, housing loans etc.) coupled with a "moderate" inflation rate accelerate a recovery or just muddy the waters and extend the length and pain of a recovery?

Moral Hazard -- you are rewarding the risk takers and penalizing the prudent savers.

There is no magic solution to the current economic mess that will make it all right . . . .
But the best result is to let the gamblers take their losses.

[Starving Steve]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

Your argument holds in a monopoly game. But we temporarily got around the basic limit of what can be financed in a monopoly game by adding a second monoply game to the system: we increased the money supply in the bank using money from a second monoply game; we liberalized the building rules so that we could build as much as we wanted to on a property; we issued IOUs to each other to prevent bankruptcies; and among other "Bernanke-like" changes, we added houses and hotel pieces to the original game's supply.

Our monopoly game went on for two or three more trips past Go, and then there was one gigantic bankruptcy. So your argument holds: in a closed money supply system, there is a basic limit to what can be financed from the bank.

We played this double monopoly game as kids one hot afternoon in San Jose, and we learned some important lessons in economics that apparently the Federal Reserve Bank has yet to learn.

As we added the second game's money to the original game and liberalized building rules, the first thing we noticed was that the cost of living on the game board went up. ( We had inflation.) The cost of living made the final bankruptcy bloodier than ever.

The most interesting thing was that the second bankrutcy--- the killer--- came quite fast. A couple of trips around the monopoly board, and it was game-over. Unless we wanted to issue more IOUs to each other, the game had reached an end determined by the money supply shortage at the bank. There was not enough money (even with the second game's supply of money added-in to the money supply) to pay the new rents on the original game board.

[Starving Steve]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

Some people are audio learners and some a visual learners. Maybe a series of videos would help some grasp it better link

There is never a shortage of money in Bernanke's world because he just prints more. Whatever the math might dictate, the printing-press repudiates it. The Fed injects money into the system whenever and wherever it is needed.

1+1= 3 in Bernanke's world. Or maybe it equals 2? Or maybe it equals 0? Or maybe it equals -1 + (a carbon credit)? Or maybe Obama would repudiate the contract and make it equal to whatever is politically-correct for that day?

Because we don't know what the hell is going on, nor what the hell the rule-of-law is, we now turn to oil and gold and our homes.

[ASH]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

Btw, Ash I'm trying as hard as I can to get my mind around the above.

I'm really just relating something that Sharky pointed out to me, which made sense. I believe the issue is timing.

As I understand things, the simplest statement of the conundrum that ricket poses is this:

The great majority of money creation is accomplished by the issuance of credit. When a debtor borrows money from a bank, the bank creates the credit more-or-less as a book entry which is spendable by the debtor, and it also makes a balancing book entry that documents the outstanding balance on the loan. Issuance of credit by the bank adds to the money supply, but repayment of the loan subtracts from the money supply. In a world without interest, the amount of money created by credit issuance would exactly balance the amount of money that needs to be paid back to the bank. However, since interest charges add to the amount of money that the debtor owes the bank, there is a potential problem that the amount of money which must be paid to the bank exceeds the amount of money which was created by the initial issuance of credit.

This would indeed be a mathematical problem if the debtor's payments to the bank were applied first to the loan principal, and the interest had to be paid afterwards. However, Sharky pointed out to me that payments made to banks by debtors include both principal and interest. This is important, because only the portion of the payments applied to principal destroy money in the system. The interest payments to the bank are collected as income by the bank, and are therefore spendable by the bank. That means if Joe Blow has a $1000 mortgage payment, of which $500 is applied to his loan principal and $500 is applied to interest, only $500 of money is removed from the supply when Joe makes a $1000 mortgage payment. Further, the $500 which the bank collected as interest could be spent in the economy, and pass back into Joe Blow's hands through his labor. Joe could of course use that $500 to make further payments to the bank. The fundamental issue is that only payments of loan principal destroy money, and since the interest payments are spendable by the bank, there is an opportunity for the same part of the money supply that is created by credit issuance to be used multiple times before it leaves the system (when payment on the loan principal is complete). Therefore, in theory, there does not have to be a mathematical problem with the supply of credit-based money and the size of the debt (principal plus interest) that must be paid with that money.

The problem, I think, is that banks mostly do not spend their interest income, but instead use it to capitalize additional loans -- and increase the supply of credit (and corresponding debt load).

[MarkL]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

Your overall argument and math is technically valid Ricket, particularly in a static economy. But you underestimate the importance of your own statement.

The only way the $2,782 extra dollars can be created is by the bank issuing yet another loan (and of course they will charge you interest).

Because (so far) both the human population and the economy is growing, continued expansion of the money supply has worked for hundreds of years, excluding small deflationary periods (like the great depression!) where the things got ahead of themselves.

Does this mean the whole economy will collapse under the weight of interest? Only if (a)The people that manage the money restrict it to the extent that loaning stops, or (b)The people lose confidence in the flow of money such that loaning stops or (c) the population stops expanding, resulting in economic growth contracting for an extended period of time.

"B" is happening now. It's been being counteracted by "a" for awhile, but hasn't caught up yet. When it does "Poom" happens, which is the opposite of deflation... what would happen if your argument's concern materialized.

You are effectively arguing that the whole economy is a Ponzi scheme. So far new babies and higher living standards have continued to generally support it. If it collapses due to deflation, it won't be the interest that is the main cause of the problem. It'll be the (to quote you) "9:1 leverage ratio" that will be the elephant in the room.

Or in the case of Citi/BA/Bear/Lehman, the 20:1 to 45:1 leverage ratio!

[Starving Steve]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

If the end happens, it will happen because Bernanke would not let anything fail. The confidence in the money would be gone for good. And that is near where we are now.

When 1/8 of the homes in the U.S. is in arrears or foreclosure, and the homes are still strongly bid--- some even going up in price again apparently in California--- the money in the U.S. is absolutely worthless.

Bernanke should never never have been seated on the FOMC, let alone become the Fed head.

[charliebrown]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

lets see if i can answer that. In a default the money still exists.
For example you borrow the 90k, buy the car mentioned in this thread, and crash it into a concrete wall. The car is now worthless. You see the 90K is now in hands of the car dealer. Who will in our simple case deposit it in the bank. Even though this loan defaults because you can't pay it back, the 90K is still out there.

Its almost like an accounting trick. Lets look at the bank's balance sheet.

Monday An asset of the bank (note for your car), gets changed to a liability (Dealer's deposit)

[charliebrown]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

lets see if i can answer that. In a default the money still exists.
For example you borrow the 90k, buy the car mentioned in this thread, and crash it into a concrete wall. The car is now worthless. You see the 90K is now in hands of the car dealer. Who will in our simple case deposit it in the bank. Even though this loan defaults because you can't pay it back, the 90K is still out there.

Its almost like an accounting trick. Lets look at the bank's balance sheet.

Monday An asset of the bank (note for your car), gets changed to a liability (Dealer's deposit)

[charliebrown]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

Upon default the money still exists, If the borrower buys a car, the manufacturer now has the "money".
If the borrower crashes the car, and can't pay the loan, the bank takes a loss on its books, (writes the loan off)
but the money is still in the manufacture's hands. It will impede the bank from making new loans. As on a bank's book a loan is an asset, and assets determine the amount of money the bank can create with new loans (bank is now a zombie bank).

Now the fed can print money right? Meaning that their books don't really have to balance (assets/liabilities; loans/deposits) The fed can choose to buy anything they want at any price simply by writting a check. However if they buy worthless assets like the non-performing loan above for par value, now the original loan money is floating around, and now the bank is free to lend again, because they have new cash (asset) to lend.

Now prices increse when there is an imbalance of money and goods. More money or less goods, prices rise; Less money more goods prices decline. Therefore the above situation causes increasing prices. Money has increased and goods have decreased (The car cannot be sold as used).

In the example above if the bank loans money for the car, there is one car's increase in the money supply and one car's value on the goods side. If the car is totaled, now there is one car's money out there as discussed above, but one less car's worth of goods. The bank can create any money because their assets are impaired. So there is some inflation here. But if the fed prints a car's worth of money, buys the loan form the bank, then the bank can make another car's worth of loans. etc. Now we have even worse inflation increase in money, decrease in goods.
The money deflates when the loan is paid back.

We have not counted for the interest in the above situation. In this case ricket's ideas come in with some amount of loans must default because the money for the interest is never created, only the principle. If the debt bubble is constantly expanding then another loan is taken to pay the interest on the initial loan. If the debt bubble ever stops growing all of a sudden a chain reaction occurs where interest can no longer be paid, and we have a chain reaction of defaults, unless like above the fed steps in an just creates money with no loan attached, and thus inflation. This is starvingSteve's notion that fed can inflate the problem away.

Am I getting this? I'm liking what I you are saying ricket.
By the way my brain really hurts.
Oh and this is why wars are such a great inflator. Loans are taken out to buy stuff that is blown up. Hence money creation without persistant goods for the money to flow into.

[Starving Steve]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

If for any reason the note on the junked car that my son crashed into a light-pole is now worthless, the bank can take the note to the Fed and get a bail-out under the TARP programme.

[ASH]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

lets see if i can answer that. In a default the money still exists.
For example you borrow the 90k, buy the car mentioned in this thread, and crash it into a concrete wall. The car is now worthless. You see the 90K is now in hands of the car dealer. Who will in our simple case deposit it in the bank. Even though this loan defaults because you can't pay it back, the 90K is still out there.

Its almost like an accounting trick. Lets look at the bank's balance sheet.

Monday An asset of the bank (note for your car), gets changed to a liability (Dealer's deposit)

It seems to me there is an issue with credit spent versus credit unspent, the capitalization of banks, and their solvency.

I think the leverage of fractional reserve lending goes in both directions. Loan default eats into the capital of the bank, so while the $90k of credit that was already spent is still out there, the portion of the money supply associated with the bad loan comes out of the bank's capital. Further, although the bank can use fractional reserve lending to create $90k of credit from just $10k of capital, if a $100k loan goes bad, it is my impression that the bank's balance sheet takes the full hit of the outstanding loan balance.

Of course, one might pursue this further and argue that when the car dealer deposits his $100k check at his bank, it will be used as the capital basis for yet further fractional reserve loans. However, this too works in reverse. The bank with the bad loan had its capital reduced by the full amount of the bad loan, and so its ability to create additional credit is reduced by the same reserve fraction. The money supply can contract if banks allow existing loans to be paid off, and reduce the number of new loans issued against their reserves. This is especially likely to happen if the loan default rate is high. (Like, you know, this whole financial crisis.)

Lastly, there is the issue of solvency. If you have a spendable line of credit with a bank that becomes insolvent, suddenly that part of the money supply ceases to exist, because the bank is no longer worthy of extending credit. Indeed, this can happen to deposits as well (although FDIC will make small depositors whole). So, loan defaults will destroy money if they cause a bank to become insolvent, by wiping out capital, and by influencing banks to extend less credit against their reserves.

[ASH]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

If for any reason the note on the junked car that my son crashed into a light-pole is now worthless, the bank can take the note to the Fed and get a bail-out under the TARP programme.

Yes. The fact that this is so -- and necessary from a policy standpoint to keep the system from imploding -- is precisely because defaults have the potential to make the money supply contract.

It seems that if pressed, the Fed could monetize toenail clippings. That's what they'd do if they had to put money in the hands of over-indebted consumers, rather than over-leveraged banks.

[aaron]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

Somewhere else on this site it is discussed and this is my understanding...

As the loan is paid back, with interest, the bank takes the interest and purchases the borrower's labor. That is how the borrower has the interest to pay the loan back.

Joe has a 100 dollar loan... he pays back 11 dollars a month.. The bank turns around, uses the 10 dollars to pay down the loan and uses the interest payment to buy Joe's great plumbing skills. Joe makes the dollar back, which he uses to pay the next month's interest.

So, there is not 110 dollars in existence.. There is one hundred dollars the whole time. It is just just passed back and forth between the bank and Joe.

IE: It is accounting.

[ThePythonicCow]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

You are effectively arguing that the whole economy is a Ponzi scheme.

All currency systems eventually fail, breaking down when they no longer adequately provide a stable and predictable exchange value for goods and services.

Monetary systems create a mechanism of exchange, valuation and storage of goods and services that is abstracted above the immediate holdings or labor of each individual.

We often hear that without a monetary system, we'd have to barter. That's just a stunted monetary system in my view. The real alternative is no system of exchange ownership of goods and services between arbitrary competent adult individuals. Robinson Crusoe had what he made. He could find berries to eat today, or sow seeds and build food storage so that he could eat more tomorrow. Families and tribes that are economically isolated can also function without a monetary system. It is understood and agreed by all who does what when and what goods are available when for common use.

Once economic groups grow larger than individuals ability to work together as a single family or tribe, then a commonly accepted unit of economic measure is required, as well as a legal system sufficient to define ownership. Whether that currency is coonskins, gold or paper money is secondary. All such currencies have risks. The essential risk is that the correlation of the currency to the underlying goods and services is unreliable. There may simply be too much or too little of the currency. Perhaps there is a die-off in the racoon population, or our explorers bring back boatloads of Aztec gold or Bernanke orders the Treasury printing presses to run too fast. Or the currency may be stolen or falsely promised, as in Ponzi schemes and pension plans that fail. The failure mechanisms are boundless.

Given that bankers (the ones we originally hire to manage the mechanics of large currency systems) and governments (the ones we originally hire to manage various other common interests, such as the afore mentioned legal system) have great self-interests at stake in the currency system and the opportunity over time to acrue great power over that system, most currency systems eventually fail, out of human greed if nothing else.

Fussing over the details of just how it is that a fractional-reserve banking system and a debt-based currency system can eventually fail is like fussing over the construction of bridges out of wood -- because wood can rot! It matters not of what we build the bridge. Stone and steel bridges fall too.

Eventually the flow and creation and destruction of wealth as accounted for by currency holdings and valuations gets too far out of sync with the underlying actual goods and services that we humans can actually use, such as food, clothing, transportation and communication. Worse yet, the correlation between the currency and the underlying goods, services, stores and productive capacities becomes too unpredictable and too unstable.

Because two of the essential purposes of a currency system are (1) to value stored wealth, and (2) to denominate time-based contracts, therefore uncertainty of the future currency denominated value of goods or services imposes a risk cost on commerce and savings.

When nations or in the present case civilizations incur increased currency uncertainty, they become poorer.

[ThePythonicCow]

Re: U.S. Economy Risks Dire Prospect of Hyperinflation

Note that it is the uncertainty that does more harm than the change. Constantly falling computer prices did not depress computer sales because those price changes were easily enough anticipated. I could reliably choose between buying a $2000 computer now, or an $1800 computer that was 50 per-cent faster next year. I have happily purchased many a computer on those terms.

It is the uncertainty that kills, not the sign or even magnitude of the first derivative. The arguments favoring modest, constant inflation on the grounds that falling prices kill economies are self-serving arguments from the banksters who profit from a debt-based currency.

Even predictable second derivative changes are handled easily, as in the pricing of annual farm crops.