Has the shadow banking system disproved the value of a non fiat currency?

[blazespinnaker]

A lot of people call for "abolishing" the fed and pegging to gold, etc etc.

However - I think the Shadow Banking System has done an end run around the CBs and the idea of a pegged currency.

If we can leverage to our hearts content, then we can create as much credit as a CB can, fiat currency or no fiat currency.

Something to think about.

I'm in favor of Frank's idea, btw:

http://www.bloomberg.com/apps/news?p...gis&refer=home

Pegging the currency to gold (or sand dollars or whatever) would just put everything in the hands of the market. Given that the market can get overly irrational at times, I'm not sure that's such a hot idea.

[c1ue]

Re: Has the shadow banking system disproved the value of a non fiat currency?

Blaze,

I thought the whole point of having a 'hard' currency was that it eliminated the ability to create credit out of thin air - thus reducing both liquidity and leverage.

Even in instances where leverage is employed, the relative levels of leverage are lower because the PM redemption possibility still exists.

Or are you saying it is possible to lever 10x or 100x even with a fully PM convertible currency?

[blazespinnaker]

Re: Has the shadow banking system disproved the value of a non fiat currency?

Well, the USD is 'hard currency' up to a point. USD doesn't just get printed to the whim of every single hedge fund / primary dealer / etc .. as much as it feels like it (though, that is happening to a degree at the moment .. hopefully only temporarily).

Gold isn't a 'hard currency' .. we dig up more everyday (quite a bit more).

Leverage creates credit simply by loaning out. Banks have to have reserves, but there are all these investment firms out side of banks that are not regulated by the fed and can leverage themselves to infinity.

Get enough of these folks working together and in concert, and suddenly you have people loaning each other based on collateral that really does not exist (which has happened to a degree at the moment).


Let me give you a simple example:

Let's say you have Anna, Bob, and Cory. Bob is the bank, and Anna and Cory have deposited 5 gold coins each with Bob.

Bob then makes a loan out to Dan who comes along of 8 gold coins (20% must stay in reserveds, because of Fred who's keeping a close eye on him).

Anna then wants to buy some paper assets from Cory, so she borrows 8 gold coins from Dan, who has no reserve requirements. She secures the loans with the paper assets, which were mistakenly given real value because the math was so complicated. Cory accepts the 8 gold goins. Cory then loans to Emily, who wants to buy some of those paper assets from Anna for 8 gold coins, who loans them back to Dan, who buys some of those the paper assets from Emily for 8 gold coins and then the cycle is started all over again.

So we've had like one set of 8 gold coins basically buy up tonnes and tonnes of paper assets, with no oversight by the federal reserve, and the paper assets get inflated in price because everyone has given them imaginary value and, hey, everyone is willing to lend and it's so easy to profit (buy 8 gold coins worth, and sell off a smaller chunk for the 8 gold coins, and you have some paper assets left over!)

Of course, it's a game of "Old Maid", where the bagholder(s) who have the loans and the paper assets lose the game at the end, and the one who has the 8 gold coins will win. But this game can go on for quite awhile.


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The problem here isn't the currency like people say it is. It's the cultural willingness to lend and speculate,to be irrationally exuberant, the inability to properly value the assets your are purchasing. People say that the RE bubble was caused by low interest rates. Perhaps. I think subprime loans had a lot to do with it, which didn't necessarily require 1% interest rates. Also, the tech bubble was not caused by overly low interest rates, if we remember correctly.

Basically, it's the all the non Warren Buffet behaviour we see. (yeah, I'm a disclipe to the Oracle of Omaha

That all being said, derivatives and financial innovations aren't all bad. They do make the markets more nimble and flexible. We just went way overboard and we need a few rules and more transparency to keep it under control. This happens when something game changing comes along (like the internet, for example, or advanced manufacturing processes before the Great Depression, etc).

..

That being said, there is a certain degree of moral hazard that the fed creates, which assists in these sorts of things. But using Gold as a hard currency comes with its own host of problems, too, that people can so easily forget.

On balance, I like the idea of the fed being more 'handcuffed' .. I don't think inflation targeting is the way to go. I'd rather see something structural where they are more damned if they do and damned if they don't, so that they generally lead to inaction on the fed rate. Monetary union really makes the most sense to me for that reason. The ECB can't raise, because they'll screw france, and they can't lower, because they'll screw germany sort of thing.

[c1ue]

Re: Has the shadow banking system disproved the value of a non fiat currency?

Blaze,

The problem with your analogy is that it is not the printing presses that are the problem, it is the lending leveraged out of 'cash'.

If all 'money' is redeemable for gold, then there is a much more real risk of a run on the bank as all said money must be redeemable for gold. There are plenty of ways around this in the short term, but there are clear limits to how much money redeemable for gold exists since too high a ratio makes a run on the bank too easy.

If instead the 'money' is a fiat dollar, there is nothing to prevent it from multiplying as the credit-->debt-->credit balloons through multiple iterations.

The reserve requirements at banks is supposed to limit this, but as we've seen reserve requirements these days are mere figments of imagination and accounting sleight of hand - reminiscent of the US Gov't double counting IMF gold in the '60s.

To speak directly to your example: Should anyone in the chain decide to redeem said paper for the original gold, the whole thing collapses. This puts a much lower limit on how crazy things can get as it only takes 1 redemption request to screw everything up.

And there are plenty of people who might be interested - for example a hedge fund shorting against the lending institution.

I suspect it is this mechanism more than the redeemability itself which is why hard currencies might be more stable.

Then again, there were plenty of bank panics in the gold dollar era.

[blazespinnaker]

Re: Has the shadow banking system disproved the value of a non fiat currency?

[QUOTE=c1ue;31345]Blaze,

The problem with your analogy is that it is not the printing presses that are the problem, it is the lending leveraged out of 'cash'.

Yes, it's leverage that killed bear sterns. Not low interest rates.

If all 'money' is redeemable for gold, then there is a much more real risk of a run on the bank as all said money must be redeemable for gold. There are plenty of ways around this in the short term, but there are clear limits to how much money redeemable for gold exists since too high a ratio makes a run on the bank too easy. They'd always want to see cash flow, margin of safety, etc.

Sometimes you need to invest in things that have a very small chance of actually making it.

Ok... How does this solve anything? Irrational amounts of leverage can still create a boom/bust scenario.

If instead the 'money' is a fiat dollar, there is nothing to prevent it from multiplying as the credit-->debt-->credit balloons through multiple iterations.

Agreed .. the credit cycle caused by the fed is a problem. But, gold has it's problems too. The credit cycle isn't the cause of investor mania, however. Investor mania is the cause of investor mania. The idea that people will become suddenly rational the world over because they're using gold instead of currency is a pipe dream.

To speak directly to your example: Should anyone in the chain decide to redeem said paper for the original gold, the whole thing collapses. This puts a much lower limit on how crazy things can get as it only takes 1 redemption request to screw everything up.

By redeem you mean a margin call? Yessss.. but then probably won't do business with you and you wono't be able to participate in the game if you go around doing margin calls for no reason. Who wants to borrow from someone like that?

Then again, there were plenty of bank panics in the gold dollar era.

yes, exactly.

I agree, gold would certainly make people more honest. It would make things more culturally reasonably, and there would be fewer moral hazards. People would be more 'risk averse'.

However ... risk averse isn't as good for the economy as people like to think it was.

I love Warren Buffet ... but god help us if every investor only acted like
Warren Buffet. Startups, internet, microsoft, all sorts of things would never see the light of day because people would be too afraid to take chances.

[c1ue]

Re: Has the shadow banking system disproved the value of a non fiat currency?

Startups, internet, microsoft, all sorts of things would never see the light of day because people would be too afraid to take chances.

B,

Here we'll have to just agree to disagree.

Microsoft is a parasite on the world; I completely disagree that a monopoly is necessary to put out a decent product.

There are numerous examples in 'hard' engineering where standards committees have been able to put together offerings integrating different companies' products into a seamless whole.

The need for an OS would have resulted in something, and darwinism could easily have produced an equally good (or better) product.

I remember clearly many of the great programs I used when younger which were killed by the MS monopoly and replaced with inferior products.

As for startups: I don't agree that money is all that motivates individuals to take risks.

Certainly there should be rewards for initiative and skills, but I have never seen why 22-year olds need to become billionaires in order to work.

The down side to the recent (not present) risk-reward ratio is you attract all of the (figurative) gold diggers - those who don't give a damn about the customer or product quality, just want their big cash.

Having departed an industry still in the late stages of 'easy money', I can attest to how these types suppress initiative and customer satisfaction in favor of short term personal enrichment and power.

[blazespinnaker]

Re: Has the shadow banking system disproved the value of a non fiat currency?

Well, sure, but once upon a time microsoft was an innovator like everyone else.

I don't mean just MS, I mean all those startups that have little chance of success (at least looking at their financial statements), but go on to change the world.

We can't be risk averse. We need policies in place that reward people who take mighty chances.

[c1ue]

Re: Has the shadow banking system disproved the value of a non fiat currency?

Well, sure, but once upon a time microsoft was an innovator like everyone else.

You mean the innovation of buying DOS?

Or the innovation of bringing monopoly tactics into software?

:mad:

Gates bought Paterson's program, called QDOS, for $50,000, renamed it DOS, improved it, and licensed it to IBM for a low per-copy royalty fee.

http://www.businessweek.com/magazine...5109_mz063.htm

Real brilliant - selling for low cost a product which costs almost literally nothing to duplicate, and obtaining a monopoly in the process.

[grapejelly]

Re: Has the shadow banking system disproved the value of a non fiat currency?

I think that people who want a gold standard are locked into an imaginary past.

The gold standard was always on again off again. Even before warehouse receipts were printed in amounts exceeding the amount of gold on deposit, the coins themselves were shaved or diluted with base metal.

What we really need is non monopoly money. Government should not have a monopoly on issuing money.

Money can be backed by anything -- Walmart can issue money in the form of store credit, for instance. Frequent flyer miles are a form of money.

I see this as the future of money -- money digitally issued by any number of issuers, redeemable and tradable via the Internet.

Just as it's time to get rid of government school monopolies and postal service monopolies, so it is time to get rid of government monopoly money monopolies.

[c1ue]

Re: Has the shadow banking system disproved the value of a non fiat currency?

GJ,

I agree with your sentiment, but in reality why would any government give up the ability to print money?