Base Money

[oddlots]

Re: Base Money

RE: #$* comments (sorry, never figured out the threads thing)

I appreciate the long explanation of your position and sorry for the delay - its taken a long time to think it through and respond. I'm still trying to get my head around it on a fundamental basis. To me the apparent strength of your argument is that it appears to give a structural explanation as to how Dollar Hegemony is actually strengthened by crisis rather than weakened (the latter point of view being my assumption and I think that of the itulip thesis.) I really want to understand it as anything that plausibly contradicts my basic thesis freaks me out these days...

The central 12 Step Hammer drill process is clear enough and should be very familiar to all of us as it bears a very strong resemblance to Hudson's Dollar Hegemony argument. (Differences are interesting - I'll get to that.) Itulip takes a very similar tack. And in fact Hudson constantly reminds us that the world has failed to come up with a response to America's exploitation of the "exorbitant privilege," which suggests that we shouldn't be too optimistic or fearful (depending on your point of view) that the rest of the world is going to free itself from this hamster wheel anytime soon, which is similar to your point of view. In contrast, the itulip thesis seems to take the point of view that Dollar Hegemony will be weakened by the "crisis" (phony or otherwise) as reflected by inflation through currency debasement and a painful process of re-industrialisation. Your position is actually quite distinct: the crisis is in fact the zenith of dollar hegemony. That's intriguing to say the least. Let's see if I understand you.

The key departure between itulip and yourself seems to me to come when the crisis comes to a head and the US is forced to create a lot more debt (treasuries) to fund "reflation." Let's suppose that the Fed's balance sheet "crisis" (no treasuries left with which to further liquify the system, as described by London Banker above) is real. Up to this point the Fed could trash its balance sheet but presumably it reaches a limit where they have to break cover so to speak and gain some breathing room by authorising some new debt. Or as London Banker put it: "The Paulson Plan would have allowed the banks to unwind the repos putting the Treasuries back in the Fed, get cash for the crap MBS, and get more Treasuries from the issues financing the $700+ billion funding of the Plan." In the itulip thesis (go easy on me Fred) this is the beginning of the end. A limit of forebearance is reached here or close to it and the sheer size of the debt required to keep economic activity going becomes impossible to ignore for holders of US $ reserves especially in the face of diminishing returns due to a tapped out US (OECD?) consumer.

In extreme contrast in your scenario this is sort of the beginning of the "gotcha phase." As you very elegantly point out, "With negative interest loans, the more you loan [borrow?] from a bank the bigger profits you get - it's the prefect investment." In other words, the more the ROW ("Rest of the World") strays away from the dollar reserve system the lighter the US's load becomes in "real" terms (inflation / debasement aids the debtor.)

That may be true but at least this far I'm not convinced. The problem for me is that I don't see this quite yet as check-mate. (Your argument seems to claim this kind of logical finality which might be its weakness.) I'll give you two examples of economic / strategic moves that seem to draw their power from a more fundamental economic truth than the admittedly powerful "our dollar / your problem" paradox. One is the fact that, as I understand it, China and Russia have bought out some of the US $ denominated loans due from South America and converted the debts to the South American domestic currency. A similar process seems to be underway in Africa where China has made development deals whereby they secure access to natural resources through a sort of payment-in-kind deal to supply infrastructure and development. (My point here is not to say these were Russian / Chinese strategic successes and, conversely, the West's strategic blunders - though I think that's true - but simply to point out that there are moves available on the chessboard that seem to offer alot more freedom from Dollar Hegemony than your analysis allows for.)

Importantly you offer a mechanism for this kind of noose-tightening action that is more pointed than simply the "our dollar / your problem" bind. Much more pointed: the suggestion is that the derivative behemoth that sits above both the simple securitised debt layer (shadow banking sector) and credit (m3) acts as a mirror image of "power money." The only salve for a collapsing derivative structure is an increasing supply of power money (treasuries.) The result is the opposite of the itulip thesis: far from being the moment of weakness this is actually the moment of US strength where the greatest value is exchanged between Soros's periphery and the centre. But I'm still a bit mystified by why this is. I sense a missing premise. Is it that treasuries are the sine qua non of collateral when it comes to OTC derivatives transactions? In other words they get a second lease on life in the OTC world as the "spit in the handshake" (in which case, let the Iranians and Russians sell oil in Zlotys for all we care... except that the derivatives market is collapsing.) I think Warburton makes a case for this when he talks about the false market in treasuries that has supported deficit spending for a generation in the west. But still I don't see you making this explicit. To me it has to be 1) more powerful than the our dollar / your problem argument as that seems vulnerable to either a) work-arounds or b) diminishing returns arguments.

Maybe you've made it clear but I didn't get it. What was the point about derivatives and treasuries. I know you've said that collapsing derivatives offers cover for increasing treasury debt - plausible FWIW - but why does this force other nations to keep playing the losing-game exactly?

Finally, I find your recourse to the David Icke action-reaction... whatever a little troubling. I think the phrase is "a night in which all cows are black." In other words, that kind of argument can turn a charge of incompetence (think BB and HP perhaps) into a charge of the worst kind of corruption while bypassing any critical judgement at all.

I'm sympathetic. I do think that the republican strategic signature is to create-a-crisis-to-which-we-happen-to-have-a-pet-solution, starting with the government destroying fiscal deficits of the Reagan years. But I really don't think they're up to the task of upstaging the last 80 years of financial history with a grand finale like this - Bush's Sendoff: Global Market Meltdown!!!!

[oddlots]

Re: Base Money

Thanks Joy. That's re-assuring. What's that fair-ground organ called? A Calliope? When economic charts start looking like a calliope sounds I get a little rattled. But surely one of these crazy charts is going to mean something. I just want to make sure I save that one as a memento.

[c1ue]

Re: Base Money

Equity in company for buying crap MBS. Since MBS isn't worth anything anyway, the government is basically buying an interest in the company to keep them afloat. Very much like an additional stock offering by the company. Also caps on exec salaries. Maybe a risky adventure, but not anything like the Paulson bailout.

Toast,

You're missing the part about the government providing the insurance against said bonds failure - at least that's the other option on the table now (from the Goldwater Repubs).

That's better than the buying of the bonds outright, but not that much better.

The purchase of preferred stock in the troubled financial companies is what Hussman wrote about in his letter; no one in the negotiation process is even mentioning that.

Because that would mean the debt holders in the FIRE companies would get spanked since the government stake would be the very last one to be hit...and there's just SO much pain to go around.

What's annoying me about this entire process is how - in the interest of 'saving the system' - all of the usual parasites are lining up to cover their own...interests...

A bailout by any other name...

[Tulpen]

Re: Base Money

The purchase of preferred stock in the troubled financial companies is what Hussman wrote about in his letter; no one in the negotiation process is even mentioning that.

Not true, it actually is on the negotiation table and may show up in the final package!

[c1ue]

Re: Base Money

Tulpen,

What's on the table is the US to gain an equity stake in the companies being bailed out. This is what the House Repubs are holding back on, among a few other things: that the government can gain should everything get better as opposed to being a profitless subsidizer.

However, the substance of the plan is still the same, the government to eat the bad debt.

Hussman's plan is completely different: no explicit purchase of said debt. All the government will do is add its money in the form of preferred stock purchases to troubled financial institutions.

The bad debt is still bad, but instead of driving capitalization ratios under legal limits and forcing confession of insolvency, the injected capital from the government would forestall the legal confession.

Why is this different? Because under Hussman's plan, everyone including many classes of existing bond holders gets what they deserve: a great whacking writedown on their bond/stock stakes.

The present government plan in contrast is a cleaning of the slates at the financial companies.

This is a corruption of the entire process: historically the cleaning of the slates is something which balances out the debtor/creditor relationship.

But instead, this time the cleaning of the slates is only on the creditor side.

Or to put it in simpler terms: All the bad debt (i.e. unpaid/unpayable) will be replaced with cash by the government. All the good debt (i.e. being paid/payable) will continue to be the monkey on the consumer's back.

You'll note mortgage modification is again being bandied about: this is an insult to everyone who refused to load down on debt in the past decade.

What this is saying is that everyone who saved their money, who was prudent financially, who didn't lie on their mortgage applications, who didn't buy monstrous McMansions and dual Mercedes, is an idiot.

[Supercilious]

Re: Base Money

Oddlots thank you for your reply. I'll try to answer your question as briefly as possible (without another mile long post)

Your position is actually quite distinct: the crisis is in fact the zenith of dollar hegemony.

If they succeed indeed to eliminate completely gold as a bank-reserve (power money) class it will be very close to the zenith of dollar hegemony.

The key departure between itulip and yourself seems to me to come when the crisis comes to a head and the US is forced to create a lot more debt (treasuries) to fund "reflation."

Basically yes. I actually don't believe US was "really" forced to do nothing (I've explained before the "real" misnomer)

Let's suppose that the Fed's balance sheet "crisis" (no treasuries left with which to further liquify the system, as described by London Banker above) is real.

I don't believe there is a "real" risk of Fed becoming illiquid. There is one more interesting detail I've red in a post made by Bart,which is an indirect confirmation for this idea:
http://www.itulip.com/forums/showthread.php?t=5518

But for now let's stay on the track.

In other words, the more the ROW ("Rest of the World") strays away from the dollar reserve system the lighter the US's load becomes in "real" terms (inflation / debasement aids the debtor.)

No. For US is a win-win game. More debt results in more negative interest loans to formal or covert peggers. Less absorption of US debts can break the peg and a collapse/downturn in the economies with huge dollar reserves. That's why the most aggressive peggers can't stop eating more and more US debt. Damn if you do, damn if you don't. It's a perfect trap that leads in the end to steps 7-8-9. Look what happens lately with China.

One is the fact that, as I understand it, China and Russia have bought out some of the US $ denominated loans due from South America and converted the debts to the South American domestic currency.

This is old COMECON tactics. This is exactly how Russia and the Eastern Block lost billions in unrecoverable debt to third wold countries when the communism crashed. The same with China's move. This is an inefficient disguised protectionism.

simply to point out that there are moves available on the chessboard that seem to offer alot more freedom from Dollar Hegemony than your analysis allows for.)

Not sure about that. We can look at the situation form a different point of view. If China is forced to maintain a very narrow currency exchange window (yuan too high economic growth stops/too low inflation and losses in subsidies and raw materials import) and they have also $2 trillion in dollar reserves, in fact one may say that China is hostage to the dollar. China is in fact dollarized on the cheap. The red 100 yuan note where Mao smiles on one side and the Great Hall is on the other is nothing else than Chinese ETN dollar certificate.

Much more pointed: the suggestion is that the derivative behemoth that sits above both the simple securitised debt layer (shadow banking sector) and credit (m3) acts as a mirror image of "power money."

Not really. The liquidity crisis cannot be treated in simple terms of the M Brothers.

"The only salve for a collapsing derivative structure is an increasing supply of power money (treasuries.)

Nope. Nobody is "really" saving anybody. The vanishing volume of derivatives form the liquidity pools (paper becoming illiquid) creates more of a back draft effect that allows for more treasuries to be pumped in the global financial system. The liquidity shock is used by the Fed to lubricate the penetration of another load of treasuries.

The result is the opposite of the itulip thesis: far from being the moment of weakness this is actually the moment of US strength where the greatest value is exchanged between Soros's periphery and the centre.

Actually I believe It's more than that, the most important aspect is the agenda to push more and more treasuries in the international financial system. The rest is secondary.

I know you've said that collapsing derivatives offers cover for increasing treasury debt - plausible FWIW - but why does this force other nations to keep playing the losing-game exactly?

It's the addiction to power money. Treasuries are now the new gold and soon they will become the only gold.;)

But I'm still a bit mystified by why this is. I sense a missing premise.

That may be my fault because I've never explained the last piece of the puzzle. Today we have a binomial standard for power money (treasuries and gold). In the 19th century Bank of England was also on a binomial standard (gold and silver). Now remember what BoE did to get rid of silver in order to impose a gold standard and imagine the same move made now by the Fed to get rid of gold and impose a treasury (completely fiat) standard:

http://www.atimes.com/atimes/China_B.../JI26Cb01.html

History of monetary imperialism
By Henry C K Liu

Over the course of the 19th century, enough gold was known to have been accumulated by Britain to make it credible for the British Treasury to introduce paper currency backed by its gold to force the demonetization of silver in Europe to advance British monetary imperialism.

Many historians inaccurately ascribe to 19th century mercantilism as the policy of accumulating gold for a country through export of merchandise. The fact is that gold accumulation can only be achieved by a purposeful policy of monetary imperialism. Mercantilism under bimetallism gave a trade surplus country both silver and gold. Only monetary imperialism could cause an inflow of gold with an outflow of silver.

In reality, Britain earned gold in the 19th century not from export of merchandise because buyers of British goods had a choice of paying in silver or gold under bimetallism. In reality, Britain accumulated gold by overvaluing gold monetarily all through the 19th century. This allowed Britain to force the world to demonetize silver and to replace bimetallism with the gold standard after enough of the world's gold had flowed into Britain to enable the pound sterling, a paper currency backed by gold, but essentially a fiat current without bimetallism, to act as a reserve currency for world trade with which to finance Britain's role of sole superpower after the fall of Napoleon.

With the pound sterling as reserve currency, British banks, operating on a fractional reserve system backed by the Bank of England, the central bank, as lender of last resort, could practice predatory lending all over the world, sucking up wealth with boom and bust business cycles instigated by her predatory monetary policy of fiat paper currency.

The strategy worked for more than a century until the end of World War I. Between 1800 and 1914, the main British export was financial capital denominated in fiat pound sterling disguised by the gold standard to be as good as gold. The factor income from banking profits derived from pound sterling hegemony paid for the wealth and luxury that Britain enjoyed as the world's preeminent power in the century between the fall of Napoleon in 1815 and the start of First World War in 1914.

The demonetization of silver stealthily turned the gold standard into a fiat paper money regime through the officially gold-backed pound sterling because the gold backing it was no longer priced in silver at a fixed rate, or any other metal of intrinsic value for that matter. Gold and only gold became a fiat unit of account set by the British Mint, a fact that made Britain the monetary hegemon of the age.

No transactional meaning
An asset that is priced by or in itself has no transactional meaning, even if it is gold. This is because a transaction must involve at least two assets of different value, expressed with different prices in exchangeable currencies. And there must be an agreed-upon exchange ratio at the time of the transaction to effectuate a transactional outcome. Even in barter, an exchange ratio between the two assets to be exchanged needs to be agreed upon. For example, an ounce of gold can be exchanged for 15 ounces of silver. An ounce of gold that can be exchanged for another ounce of gold carries no information of transactional value.
Thus the pound sterling, even when backed by gold, was in fact a fiat paper currency because the monetary value of gold is set by fiat devoid of any relationship to any other thing of intrinsic value beside gold itself. Without bimetallism, specie money cannot have any meaning of transactional worth. Currency backed by gold turns into a fiat currency if it can be redeemed at its face value only in gold. The monetary value of gold is not separate from the commercial value of gold. Gold then can fluctuate in purchasing power due to any number of factors, including government policy, but is not fixed to any other metal of intrinsic value at a universally agreed upon ratio.

That a pound sterling is worth another pound sterling is no different than an ounce of gold is worth another ounce of gold. And the market price of gold can be manipulated by the government that is in possession of more gold than any other market participant. This means that any unwelcome speculator can be quickly ruined by the government. This is of course how central banks nowadays intervene in the foreign exchange market for fiat currencies. Central banks with sufficient dollar reserves, a fiat currency, can drive speculators against their national currencies toward bankruptcy.

Before silver was demonetized, the silver/gold ratio was set monetarily at 15.5/1 in England and 15/1 in France, motivating speculators to buy silver with gold in England and buy gold with silver in France for an arbitrage profit of half an ounce of silver for each ounce of gold so transacted in the two countries. This caused a continuous flow of gold to England independent of international trade flows in other commodities. Even when Britain incurred a trade deficit, gold continues to flow into Britain because of the monetary hegemony of the pound sterling.

After silver was demonetized, gold could be exchanged at the British Treasury only for pound sterling notes at the rate of 21 shillings, or one pound one shilling, per ounce of gold fixed in 1717. The commercial price of gold in England was set by the British Treasury on par with its monetary value because the gold price was denominated in pound sterling. The commercial price of silver or any other commodity in England was also denominated in pound sterling, which had a monetary value in gold set by the British Treasury by fiat.

After the demonetization of silver, no one knew how much silver was worth as money because it was no longer used anywhere as money. Thus there could not be any discrepancy between the commercial price of silver and its monetary value because silver ceased to have a monetary value. Silver then became a commercial commodity like any other commercial commodity, while only gold remained a monetary unit of account accepted in the British Treasury and in other treasuries of countries which observed the gold standard. Countries that refused to join the gold standard saw their currency kept out of international trade and had to pay a penalty of high interest rates on loans denominated in their non-gold-backed currency.

The Bank of England could issue more pound sterling notes by fiat based on the fractional reserve principle in banking. She only needed to keep enough gold to prevent a run on pound sterling notes for gold at the Bank of England. And since England was in possession of more gold than any other country at the time, Britain under the gold standard became the monetary hegemon, with more money at her disposal than justified by the amount of gold she actually held. Other gold standard countries had to maintain a much higher fractional reserve in gold than Britain and therefore had less money with which to participate in international capital markets. The monetary hegemon could sustain a trade deficit with an inflow of gold caused by monetary policy.

Without a fixed exchange-rate regime, each nation could adopt a gold standard unrelated to other nations' gold standard. For example, the US at $20.67 per ounce of gold and Britain at three pounds, 17 shillings and 10 pence per ounce of gold would let the exchange rate between the dollar and the pound sterling work itself out mathematically. This is what a fiat currency regime does, except instead of being valued by a gold standard based on the amount of gold held by the issuing government, the exchange rate of the currency is valued by each country's monetary policy implications and financial conditions, such as interest rates, balance of payments, domestic inflation rate, fiscal budgets, trade deficits, and so forth.

The United States, though formally on a bimetallic (gold and silver) standard, switched to gold de facto in 1834 and de jure in 1900. In 1834, the United States fixed the price of gold at $20.67 per ounce, where it remained for a century until 1933, when president Franklin D Roosevelt devalued the dollar to $35 per ounce of gold, but made it illegal for US citizens to own gold in amounts worth more than $100.

There are some important tactic differences between the simple approach of the BoE in the 19th century and the sophisticated mechanism used by the Fed today, but the big picture should be obvious.

[Supercilious]

Re: Base Money

One more thing oddlots... this is fresh from Bloomberg:

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

The Federal Reserve will pump an additional $630 billion into the global financial system, flooding banks with cash to alleviate the worst banking crisis since the Great Depression. The Fed increased its existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The Term Auction Facility, the Fed's emergency loan program, will expand by $300 billion to $450 billion.

Yup.. can you believe that??? Ben is flooding the global financial system with more treasuries!!! ... Isn't that surprising ?