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Has the dollar ever been worth more than a dollar? Has the pound ever been worth more than a pound?
I expect an ongoing flight to primary qualitas.
Several big corporations got bailed out one way or the other.
And now we see that several countries "need" to be bailed out some way or the other.
Who will bail out the biggest countries? Simply the electronic fiat-money printing press?
Well let’s hope the world economy stabilizes before the house of cards is bailed out with air, air and house of cards are not always a good combination.
Hope for the best, plan for the worst!
www.federalreserve.gov excess reserves
There has been a series of stories about this, how it potentially indicates money not is getting out to the people. That the unemployment now stands at between 10% to 20% possibly indicate that the money not is getting out there. But this could naturally also be related to other factors.
Several people have also claimed the massive excess reserves at some point down the road will cause considerable inflation. The idea is as long as the velocity of money stays low we will not see inflation, we could even see deflation. But when the economy stabilizes and lending activities picks up and the velocity of money picks up then the excess reserves now flowing into the system and working as a money multiplier could cause inflation:
Inflation is looming on America’s horizon
In an interesting report from FED July 2009 it is claimed that the excess reserves neither means the banks not are lending out their money and further that the massive excess reserves are unlikely to cause inflation down the road:
Why Are Banks Holding So Many Excess Reserves?
Thanks to a “new invention” FED claims things are different this time around. The new invention is to pay interest rates on excess reserves. Paying interest rates on excess reserves where introduced by the Emergency Economic Stabilization Act of 2008, and this is the new magic trick among central banks around the world.
FED now supposedly have much better control of when and how much of these excess reserves will go into the economy in form of increased lending.
FED’s report seems to be based on a series of hidden assumptions. They do not seem to take into account that FED has much less control over the long-term interest rates than the short rates. If the long-term interest rates went much higher than short rates and the economy at the same time picks up could it not happen that banks will start to lend out their excess reserves to long-term investments to get higher returns? And what about the equity markets and other markets, if the returns here should be great over an extended period of time would it then not be tempting for banks to increase lending to get considerably higher returns than on their excess reserve accounts?
Possibly I am completely wrong, I am far from an expert on excess reserves in the banking system. However to me there simply seems to be too many unknown factors that potentially could limit FED’s control over the excess reserves and thereby the money supply.
The central bank system also seems have very limited experience with how much extra control they actually gain over money supply and money multiplier by giving interest rates on the excess reserve accounts. FED mentions that The Reserve Bank of New Zealand has used this type of framework since 2006. But what is 4 or 5 years experience?
The record high gold price seems to tell a different story. People are normally moving towards gold when they start loosing their faith in the monetary systems ability to sustain stability in the value of legal tender. The high gold price is probably also a way for parts of the market to say they fear inflation coming down the road. What if FED is wrong in some of their assumptions, what if these massive excess reserves at some point down the road should cause massive turbulence and or inflation? It could naturally take many years before we know the answer to this question.
Last time the excess reserves where ballooning was under the great depression. Excess banking reserves in USA were just above 70 million dollars in 1929. In 1935 they had exploded to 1282 million dollars.
But this time everything is different; the central bankers have finally found the solution, the magic trick of giving interest rates on the excess reserves will be our savior this time around. I hope and wish it is this simple, but I am afraid not!
M1 is way up, M3 is flattish (or slightly down) likely due to the falling velocity of money.
When the velocity of money at some point picks up it will be interesting to see how well FED can control the total money supply of the economy.
But yes we can clearly get deflation before we get inflation. Well there has already been quite a lot of house price deflation around the world.
Snakes and banks have a few things in common, they both have a lot of muscles. If you ever had a python snake around your neck you can feel it has a lot of muscles. Banks have the muscles to create money through credit expansion. Central banks have the mucles to create money and to set the official interest rates, manage the currency reserves etc.
When the credit bubble busted the short-term fix was relatively simple. Central bankers and politicians could replace much of the shrinking credit-money (credit contraction) with fresh money from the central bank “electronic printing press”. The money was used to bail out banks and financial institutions that based on horrible risk management (of credit) suddenly were imploding and still keep imploding. Well only the too big to fail got bailed out, the small banks went bankrupt or got swallowed up by super banks that had got billions and billions in fresh bail out money.
Fresh money is also used to buy the countries own debt. This to keep interests down and avoid further panic.
Many snakes can also be poisonous (luckily the python around my neck is not). If the central banks print too much electronic money it could at some point become poisonous for the lifeblood of the economy. The potential poisonous lifeblood of the economy is now congested around the heart of the economy. If the congested lifeblood dose not spread out in the economy it could at some point cause another heart attack with a lot of chaos in the world economy. In a big body (the world economy) it normally takes a lot of time for the lifeblood to spread out. Unemployment is up in most countries and consumer spending is down, the blood is simply congested around the heart of the economy. If the congested potential poisonous lifeblood should reach out in the economy it could down the road cause high inflation and or weakening of certain currencies.
If you fear the lifeblood of the economy could be poisoned you should consider investing in antidotes now. Personally I would think a good antidote diluted in water is reddish in color, it looks like wine, but do not taste like wine (few people have tasted it, but most people have touched it), I say no more….
To understand a snake you have to feel it, touch it, smell it. A true serpent master does not fear snakes. Snakes should fear him!
Why?
Think of someone measuring his strength by how much volume he can lift rather than using a standardized scientific weight for measurement. One day your iron dumbbells are replaced by air filled plastic dumbbells with 3 times the volume of the iron dumbbells (but much less scientific weight in kilograms). Based on this a newspaper reporter writes that your strength has exploded. Great!
This is almost like listening to economists claiming the recession must be over in some countries because central banks have pumped loads of fresh FIAT-money into the system and thereby also helped inflate their GDP numbers.
It looks like GDP is back up raising in a few countries hit by the financial crisis. But how do we measure GDP? Yes by money, but if the money supply in reality has been increasing then the real production could be down even if GDP looks like it is up. Today’s popular inflation measures and money supply measures are horrible at keeping track of the long-term relevant money supply. Talking about GDP measures as if it was scientific weight measures also makes it looks like the central bankers and politicians are in control of the situation. They have accurate measurements of the situations and the tools to tune the economic machinery. I wish!
The central bankers have used their magic wand to make it looks like GDP is doing okay. Politicians and central bankers massive bail out of financial institutions is not the same as increased production. GDP growth in times like these could be illusionary. Central bankers have very limited control over the velocity of money, it could fall further, making the central bankers panic further with their electronic printing press. Or the velocity of money could come up to more normal levels. Together with increased “real” money supply this could cause inflation and or panic out of certain currencies. There are many scenarios and GDP is an extremely inaccurate measure to say anything.
If GDP suddenly should shoot up at the same time as unemployment is increasing this could simply mean a combination of increased money supply together with the velocity of money coming somewhat up from lows. When and if the velocity of money comes back to “normal” then we will see the true and relevant money supply. It is for sure way up. This mean that in the long run a series of fractional-FIAT currencies likely must come down in value one way or the other (this could take months or many years). Relative to what? Use your imagination. Before that happens the velocity of money could fall further, causing the central banks to speed up the electronic printing press (causing even bigger problems in the long run). I do not know where the velocity of money is going, I do not know where the GDP is going, but I know central bankers are running their electronic printing press. The measure stick used to measure GDP is quickly changing its length and this is not captured in central banks naïve and lagging inflation measures.
Growth in GDP does not need to reflect increased production in the economy. Changes in GDP can just as well be changes in the length of the measure stick. That is changes in the velocity of money plus changes in “real” money supply. We know the central bankers have been increasing the money supply + we know the velocity of money likely is highly volatile in times like this. The fear and greed volatility is still high. Small changes in GDP measures could be close to meaningless in situations like this.
Under a fractional-FIAT monetary system the “standard procedure” of solving any credit contraction is to expand the money supply to bail out miss-managed banks and inject massive amount of money into the system to counter effect the reduced velocity of money. That is to move the cost of incompetent bankers and over expanded businesses to the government, basically privatize the profits and socialize the losses. The massive credit expansion was not the result of free market forces, supply and demand driven economy; it was likely the result of a non-optimal monetary system that over a long time period of gave the illusion of stability, and still gives illusion of stability.
The massive amount of quantitative easing that have taken place by a several central banks and that still are taking place will more likely than not result in massive side effects down the road. The question is when, timing is everything, and I do not know when, but can try to do a "qualified" guess. I would not be surprised if the current world reserve currency USD could come under attack over the next 6 months, so will also other currencies. Personally I expect increased instability in the FX markets at some point over the next 6 months. Increased volatility will probably not come gradually, but more like a panic wave down the road.
The reduced velocity of money keeps inflation down and makes it looks like FED and other central banks are in control of the situation. Trying to resolve the problems of a credit contraction by pumping in massive amount of fresh money into the system and hoping all will be well is like walking a thin wire between two large towers. You can easily fall down, the line can break. To walk the line without any accident you need a lot of luck or a lot of practice from similar situations. No central banker have a lot of real life experience from similar situations. To read books, studying data or even being a professor about walking a thin wire between two towers could help you understand how difficult it is. Theory will however unlikely make you a specialist in walking a thin wire. All you can know is that it will be a very dangerous operation.
Unemployment seems to be increasing rather than decreasing. Businesses are closing down. And for sure we know the money supply has increased, only the low velocity of money keeps inflation down, and falsely make it looks like the money supply is under control. Massive amounts of quantitative easing are unlikely to come without massive side effects.
I could naturally be mistaken about the whole situation. But as someone that wants to protect my most valuables it is always cheaper to invest in a warm hat in the summer than to wait until you potentially are in the middle of a tail event ice-cold winter. Few people demand warm hats in the summer, most people wait for the ice cold winter, and no one can know for sure how cold the winter will be, it could be mild, it could be ice-cold, but with a warm hat it will likely be mild no matter how cold.
This is the time to protect yourself from a potential second wave from the monetary system crisis. Many economists and talking heads claims the central bankers now have crossed the thin wire and now are on safe ground, but the picture is very foggy. Fog means uncertainty about where you are and about the terrain where you are moving. And even if they have been able to cross the thin wire between the two towers and they now again feel on safe ground it could be that the tower suddenly collapses under their feet. Lets hope for the best but plan for the worst. Warm hats are now cheap, but the fall is soon here and the prices could soon be increasing, it was not hard to bargain on the price of a warm winter hat while still in the summer.
Left wing politicians are now blaming right wing politicians, and other way around.
Politicians are blaming greedy bankers.
Bankers are blaming greedy politicians.
Risk mangers are blaming the market.
Some quants are blaming the bad models.
Some supermodels are blaming their manager.
Good quant’s are blaming the bad quants.
Bad quants are or potentially should blame their professor not teaching them about the flaws in the model.
In a Nordic country I was reading the women now are blaming the crisis on the men (mostly men was in leading finance positions).
I was recently reading someone blaming the credit crunch on cosmic radiation.
Madoff I think blamed how he got involved in the pyramid scam on that he lost some money in last recession.
Some now wants to sell stocks because they fear deflation, others wants to buy stocks because they fear massive inflation. Few people buy stocks because they trust the system.
In a economy where trust is more important than anytime before how can the crisis soon be over when trust seems to be fading all around the globe?
In August 2008 the excess banking reserves in USA were 4 billion dollars. In January 2009 the excess banking reserves had exploded to more than 900 billion dollars. The excess banking reserves have recently gone down a bit, but high volatility even in excess banking reserves can be expected in times like this. Personally I think we likely will see new highs in excess banking reserves in the months to come. More and more people and banks will simply sit on their money. Few companies are in need for expanding when demand is falling, most companies need to cut back on their businesses and their loans.
There are simply not that many good projects to lend out money to these days. It is about surviving. The main cause of the mega bubble bursting in front of us was too much debt. There is a limit in how many times central banks can fix a debt bubble by trying to create an even bigger debt bubble.
The velocity of money is down, industry production is falling rapidly world wide, more people are getting fired… we are in a bad cycle feeding on itself, just like the credit bubble was feeding on itself. A lot of money is simply accumulating as excess banking reserves; it could take a long time before the confidence is re-established and the velocity of money picks up again.
Down the road there is also the danger that economic chaos will spill over in political chaos. From order there will likely be more chaos before some type of “order” again return.
I also made a few comments on excess banking reserves in DN today (for the few of you reading Norwegian)
Unfortunately macro models are probably much worse in describing reality. Central banks relaying on such models have much bigger impact on society than a option trader that relies on dynamic hedging to remove all risk in a few options and then blows up.
Can bad macro models potentially abused by the central banks blow up the economy of whole countries. I think possible yes, at least as an important contributing factor. Well I guess they are not too worried as they mainly play with others peoples money...
Injecting a lot of new money into the system should at some point spill over in inflation, but an important point to take into consideration could be the velocity of money. The velocity of money has to do with how quickly money change hands. Some macro economist think the velocity of money is not very important, other claims it is very important, personally I am in the later category. If the money supply is growing but just getting stashed away then we can still get deflation in common goods, even good businesses can be forced to close down due to reduced demand, businesses will go bankrupt, production will fall, unemployment will rise, and we are entering a bad circle feeding on itself, just like the madness of the credit boom was feeding on itself.
The velocity of money is probably closely linked to the confidence in the economy. If the confidence of the economy goes down so dose typically also the velocity of money. Even if I have money to spend I am less confident in the future of the economy, so it is rational for me to hold back a little even if the government should send me a check of money, I just stash it away. When many think the same this will reduce the velocity of money. This do not reduce the money supply but the speed of which money change hands.
Of course when the velocity of money comes back to “normal” at some point then together with increased money supply this will lead to inflation and potential even hyperinflation. However there is reason to think the velocity of money could stay low for quite some time, this again could result in more bankruptcies, more unemployment and deflation. Which again means the government will try to print even more money to solve the problem, but if the problem is velocity of money and not the money supply then this will not solve the problem, but just plant more seeds for deflation to spill over in massive inflation at some point down the road, it could take months or years, who knows.
Under the great depression money with time stamps got introduced. Or more precisely money that you had to pay a tax for if not used by the end of a given time limit. Of course most people wanted to avoid such tax, and people therefore tried to use the money as soon as possible, in other words the money quickly changed hands. If the government should handle out more money possibly they should think of handle out a version of such high velocity money. With today’s electronic fiat money there could be interesting possibilities for developing various sorts of high velocity money with some sort of time limit. Not necessary a suggestion, but something that we should look into before we potentially need it and not after we potentially need it. But it is always dangerous to play with something we have little experience with.
