Bernanke's Next Parlor Trick

[thousandmilemargin]

Re: Bernanke's Next Parlor Trick

So, who's going buy that mountain of low-yield government paper?

The banks.

Old system:

Fed creates money out of thin air as it loans money to banks, who loan it to consumers, who spend it on SUVs and real estate speculation. Banks skim off fat profits.

New System:

Fed creates money out of thin air as it loans money to banks, who buy bonds, in effect loaning money to the Government, which spends it on pork barrelling, payoffs and makework schemes for social activists. Banks skim off fat profits.

The funny thing is that the markets only seem to worry about "monetarization" of debt if the Fed buys bonds directly with newly created money. If they create money out of thin air and loan it to JPM, and JPM buys bonds, then that's just the system at work, nothing to see here folks, move along.

Mish and Steven Keen will tell you that inflation can't happen because the system for transfering newly created money into the economy has broken down - the banks aren't lending.

But the banks ARE lending - to the government. That's what happens when you buy Treasuries - you're loaning money to the government. Duh.

So if the government is willing to step into the shoes vacated by the consumer and start spending, you have yourself a new mechanism for the transmission of inflation.

The current deflation environment is explained by the fact that it takes a long time for goverment spending to get moving - very little of the $700 billion stimulus package has made it out into the economy yet, not that it's much money anyway. I'd guess it will be another 12 months before the goverment starts to really hit its stride and starts to borrow and spend a trillion per quarter. First there needs to be a political environment that makes borrowing a trillion a quarter sounds like a GOOD IDEA - screams of "Do something, do something, anything!".

Look for that after the next leg down. People are not that scared yet,mostly in denial, you need real terror to generate enough goverment borrowing to create inflation.

[metalman]

Re: Bernanke's Next Parlor Trick

Old system:

Fed creates money out of thin air as it loans money to banks, who loan it to consumers, who spend it on SUVs and real estate speculation. Banks skim off fat profits.

New System:

Fed creates money out of thin air as it loans money to banks, who buy bonds, in effect loaning money to the Government, which spends it on pork barrelling, payoffs and makework schemes for social activists. Banks skim off fat profits.

The funny thing is that the markets only seem to worry about "monetarization" of debt if the Fed buys bonds directly with newly created money. If they create money out of thin air and loan it to JPM, and JPM buys bonds, then that's just the system at work, nothing to see here folks, move along.

Mish and Steven Keen will tell you that inflation can't happen because the system for transfering newly created money into the economy has broken down - the banks aren't lending.

But the banks ARE lending - to the government. That's what happens when you buy Treasuries - you're loaning money to the government. Duh.

So if the government is willing to step into the shoes vacated by the consumer and start spending, you have yourself a new mechanism for the transmission of inflation.

The current deflation environment is explained by the fact that it takes a long time for goverment spending to get moving - very little of the $700 billion stimulus package has made it out into the economy yet, not that it's much money anyway. I'd guess it will be another 12 months before the goverment starts to really hit its stride and starts to borrow and spend a trillion per quarter. First there needs to be a political environment that makes borrowing a trillion a quarter sounds like a GOOD IDEA - screams of "Do something, do something, anything!".

Look for that after the next leg down. People are not that scared yet,mostly in denial, you need real terror to generate enough goverment borrowing to create inflation.

learned a new trick!

[Slimprofits]

Re: Bernanke's Next Parlor Trick

Writing for Gluskin, not Merrill, David Rosenberg said the same thing, but two weeks ago. i.e. with rates approaching 4% the big banks could be counted on for some big purchases

[dummass]

Re: Bernanke's Next Parlor Trick

Sharky, your video doesn't prove your point; in fact it does the opposite. Your video sidesteps the interest charged on the Treasury Bond. This is the point that others here have been trying to explain to you. The money to pay the interest on the bond has not been created. Perhaps you should read the comments that were posted to the video you recommended.

[Sharky]

Re: Bernanke's Next Parlor Trick

Sharky, your video doesn't prove your point; in fact it does the opposite. Your video sidesteps the interest charged on the Treasury Bond. This is the point that others here have been trying to explain to you. The money to pay the interest on the bond has not been created. Perhaps you should read the comments that were posted to the video you recommended.

Sigh. The bank loan in the video was completely paid off, including interest, with no additional money being created.

Additional money to pay off the bond doesn't need to be created. To pay it off, the Treasury would first pay the Fed the interest that's due. The Fed then, as it already does, would rebate the interest earnings back to the Treasury. Treasury would then have enough to pay off the principle.

The key point is this: money circulates. It doesn't get used once and then thrown away. The same dollars can be used to pay both interest and principle. The problem comes only when lenders allow borrowers to indefinitely compound interest due. In a normal scenario, loans and interest can be paid with only a fixed amount of money in existence.

[Diarmuid]

Re: Bernanke's Next Parlor Trick

Really? What about all of the tellers they hire? What about all of the things they buy? All of those expenses come from income (interest), which is recirculated into the economy.

In my opinion so called money (debt) being cycled back into the real economy is minimal via tellers wages etc.. - it is in being recycled back into the shadow economy, further destroying capital and production. So the idea that there is never enough money in circulation to pay the debt is a valid one albeit simplified.

[Slimprofits]

Re: Bernanke's Next Parlor Trick

Maybe I'm missing something here. In general, bank branches have a handful of employees working each shift (5-10).

Seems like an insignifacant drop in the bucket.

[Sharky]

Re: Bernanke's Next Parlor Trick

In my opinion so called money (debt) being cycled back into the real economy is minimal via tellers wages etc.. - it is in being recycled back into the shadow economy, further destroying capital and production. So the idea that there is never enough money in circulation to pay the debt is a valid one albeit simplified.

If by "shadow economy" you mean the financial sector, then those bank earnings are still circulating in the economy. As long as the bank doesn't sit on the earnings, they will be available to pay interest on loans.

Maybe I'm missing something here. In general, bank branches have a handful of employees working each shift (5-10).

Seems like an insignifacant drop in the bucket.

Have a look at the income statement for a bank. It's not just the tellers; all of the money they spend circulates in the economy: real estate (construction workers, materials, etc), utilities, advertising, equipment, supplies, management, vehicles, dividends paid to shareholders, etc, etc. Even the taxes they pay circulate back into the economy, in the form of government spending.

[Diarmuid]

Re: Bernanke's Next Parlor Trick

Just saw Sapiens posted this - it is a follow u[p to money as debt and further expands on the idea of the prinipal plus interest and money re- circulation ideas. Just posting it here as is relevant to discussion

http://www.itulip.com/forums/showthr...ght=money+debt


quote=Sharky;104221]If by "shadow economy" you mean the financial sector, then those bank earnings are still circulating in the economy. As long as the bank doesn't sit on the earnings, they will be available to pay interest on loans.



Have a look at the income statement for a bank. It's not just the tellers; all of the money they spend circulates in the economy: real estate (construction workers, materials, etc), utilities, advertising, equipment, supplies, management, vehicles, dividends paid to shareholders, etc, etc. Even the taxes they pay circulate back into the economy, in the form of government spending.[/quote]

[gorkypark]

Re: Bernanke's Next Parlor Trick

In a normal scenario, loans and interest can be paid with only a fixed amount of money in existence.

With all due respect, when aggregate debt outstrips the productive component of GDP to the extent that it has, I fail to see how your model (as illustrated in the video link) could be plausible. Where does the cash flow come from to service the debts? Only a 'greater-fool' Ponzi model of asset inflation based on perpetual debt creation kept this circus going, and now is on life support...

[dummass]

Re: Bernanke's Next Parlor Trick

Sharky

It's like playing musical chairs. As long as the music doesn't stop, one can maintain the appearance of plenty of chairs. This is especially true when you have Trillions of chairs.

You are right. The Treasury can create another chair; however, in doing so, the Treasury will also creates another debt and the associated interest charge. We will still be missing a chair.

Can money continue to grow in this manner, for ever? or will the music stop at some point?

In either event, dollars (like chairs) will remain in scarce supply.

[WildspitzE]

Re: Bernanke's Next Parlor Trick

My argument is that it doesnt matter about defaults, because defaults are designed into the system (and banks know this). People say that banks hate defaults, but it's a mathematical inevitibility and banks use "defaults" as a way to confiscate property, which in any definition is also called THEFT.

Again, the banks don't lose from debt defaults. They confiscate real property. They may not be able to sell it and break even, but eventually they will accumulate enough property (through inevitable defaults) to set their own prices at some point in the future.

Haven't been on itulip since my last post, and perhaps others have addressed this already.

To address someone else's assertion first as a lead in, defaults don't reduce the current money supply, but they may potentially affect that bank's ability to create new money in the future. That is, only if such defaults adversely affect the bank's capital. And yes, a certain amount of defaults are built into the system based on a static concept of money supply.

In order for defaults to affect capital, the write-offs associated with defaults (as well as other losses, i.e. mark to mark losses) have to be larger than the excess spread that the bank generates. If so, then the losses eat into capital.

Excess spread, simplistically, is composed of net spread (difference between their cost of funding and the revenue on performing assets), fees, and recoveries.

"Recoveries" is in essence any cash that the bank gets once they've written an asset off. Whether it comes from the ultimate disposition of collateral (say, the bank sells a house associated with a mortgage), or if it's cashflow (say, if a court allows for [a capped] garnishment of a wage associated with the default of credit card debt), either is excess spread because the bank has written off the entire value of the loan.

If the ultimate recovery is larger than the loan value that was written off, then they may have not experienced a loss (in the long run, net of expenses, and you must account for PV). That said, most jurisdictions that I've analyzed have a cap on recoveries - largely based on the loan amount that was written off plus expenses to recovery (e.g. legal fees).

Recoveries are not instantaneous, and for the most part take a long time to materialize because the non-voluntary ones involve the legal route / court system. The exception is obviously when people volunteer for a restructuring or workout plan.

As I've said many times before, as the leverage in the system approaches infinity, correlation between assets approaches 1. Portfolio theory breaks down, and the net effect on recoveries is that your recovery values approach zero and your recovery timeline approaches infinity. Risk management should learn that as systemic credit approaches infinity their collateral requirements should increase, not stay static based on what recoveries are in the good times, nor should the amount of excess spread built into their loans stay the same. However, here it's clear how free money has unintended consequences that affect these decisions.

Based on historical precedent, and mandate, during a crisis the large banks don't really care about defaults because of the FED, not because of recoveries (or collateral). What your post missed is the effect of timing. The FED provides a bridge in a banks capital between the time "losses" overcome excess spread, and when excess spread then overcomes the "losses". This is the FED's mandate, otherwise the Banks would be outright insolvent (especially as the reduced capital would then prevent them from originating new excess spread generating assets).

In this context, this is why the treasury-bank arb that I've been mentioning before makes total sense from the FEDs perspective. I thought it was obvious when I posted it. It allows the banks to generate excess spread while minimizing the risk that such new assets contribute to defaults (given that it's the government). Additionally, under such arb, the government then spends it on people which ultimate means that they'll have cash to pay their existing loans (and hopefully reduce further defaults or cure situations) or provide wages / cashflow to lend against (new excess spread generating assets). Under the arb, the inflationary leakage is largely the non-taxed piece (the taxed being used to pay on the treasuries / and now muni debt).

[Starving Steve]

Re: Bernanke's Next Parlor Trick

The brainwashed economists coming out of the universities to-day think that they can de-value paper money forever and run real estate prices up forever and create debt forever and dump deficits onto children forever --- and call that an economy. This system is so toxic now that far more is gained by letting it collapse into ashes than to have it continue on life-support with Bernanke and his bail-outs.

The economists and the ecologists have nothing to offer the world but more lies, more government control, more wishful thinking, and more inflation. And the world needs to face the facts about these two groups, otherwise there will be no recovery from this mess.

[ricket]

Re: Bernanke's Next Parlor Trick

Sigh. The bank loan in the video was completely paid off, including interest, with no additional money being created.

Additional money to pay off the bond doesn't need to be created. To pay it off, the Treasury would first pay the Fed the interest that's due. The Fed then, as it already does, would rebate the interest earnings back to the Treasury. Treasury would then have enough to pay off the principle.

The key point is this: money circulates. It doesn't get used once and then thrown away. The same dollars can be used to pay both interest and principle. The problem comes only when lenders allow borrowers to indefinitely compound interest due. In a normal scenario, loans and interest can be paid with only a fixed amount of money in existence.

So what would happen if a bank didnt spend back into the economy 100% of the money it received as interest payments (in the video this was the $900 that "You" received when the bank bought your product)? What happens if the bank sets aside some of the interest payment from your employer, and instead of buying your product, hands it out in dividends or as interest on a savings account? Also, what happens if the employer spends the entire $9,000 and doesnt set aside the $900 to pay interest? Given all the problems that it creates shouldnt it be against the law to have non interest-reserve loans? All of these inconsistencies make your model of perfect money creation break down, since the real world functioning is vastly different than what you describe.

I do, however, get your point that money does circulate. It has helped me think deeper about my beliefs in this matter, but I think that the sheer volume and amounts of interest bearing transactions that take place every day (at least before the credit "crunch") far outweigh the amount of spending the bank and it's employees can spend back into the economy that is necessary to "zero-out" the balances on every account. Most of that money that your employer will pay in interest to the bank will never make it back onto your balance sheet, but will instead accumulate in someone else's account (which I'm sure theyll let you borrow it, at interest of course ;) ).

Another flaw is that the amount of interest on the account is always less than the principal amount. A 200k mortgage over 30 years will accrue 230k in interest, at roughly 5%, over the life of the loan, thus making it impossible to pay the interest from the original amount borrowed. Paying a one-time 10% $900 payment on an original $9,000 amount is possible, but only because it's a one time charge and the amount of interest owed is not higher than the entire principal amount created in the first place. You touched on this fact with your comment on compound interest, but we can all agree that most loans in existence today are built on compound interest.

[Sharky]

Re: Bernanke's Next Parlor Trick

With all due respect, when aggregate debt outstrips the productive component of GDP to the extent that it has, I fail to see how your model (as illustrated in the video link) could be plausible. Where does the cash flow come from to service the debts? Only a 'greater-fool' Ponzi model of asset inflation based on perpetual debt creation kept this circus going, and now is on life support...

There are two different issues here. The first is whether it's possible to pay off interest on a loan without creating new money. I hope I've demonstrated that it is possible.

The second issue is what happens when interest is allowed to excessively compound. In that case, it does eventually become unpayable, because the amount due will eventually exceed the income of the borrowers. In that case, if the borrower is the government, they can inflate and attempt to continue making interest payments with inflated dollars. However, the process is exponential, and so will inevitably end poorly for both lenders and borrowers.