Need reference to help me understand basic monetary theory

[Benko]

Looking for recommendation for something I can read to help me understand basic monetary theory.  Preferably the cliff notes version, unless I really need the war and peace version.  This was prompted by the below, which could very well be some doomsayer (probably given his book title), but I don't understand enough to be able to tell.  I get that we left the gold standard, but don't really UNDERSTAND the rest.

http://www.cnbc.com/id/48193471
“We’re in a very unfortunate position to be here,”? Richard Duncan, author of The New Depression, warned on CNBC’s “Squawk Box Europe”? Monday.

"“When we broke the link between money and gold, this removed all constraints on credit creation. This explosion of credit created the world we live in, but it now seems that credit cannot expand any further because the private sector is incapable of repaying the debt it has already, and if credit begins to contract, there’s a very real danger that we will collapse into a new Great Depression,”? he argued.

“If this credit bubble pops, the depression could be so severe that I don’t think our civilization could survive it.”?

The explosion in cheap credit has been widely blamed for the global financial crisis, but the debate about how to fix the problem continues.

In the past few years, central banks including the U.S. Federal Reserve  , the European Central Bank  and the Bank of England have pumped liquidity into their financial systems through a number of ways, including quantitative easing  and the ECB’s long-term refinancing operation (LTRO)..."

[Pointedstick]

I recommend http://pragcap.com/understanding-modern-monetary-system

But the cliffs notes version is that we live in a debt-based monetary system in which all money is created by debt. Banks do it when people borrow to spend, and governments do it when they run a deficit. A federal government deficit represents the government putting more money into the private sector (through spending) than it removes from it (through taxes). A balanced budget is undesirable since it kneecaps the liquidity of the money supply, which could lead to deflation. In fact, in recent years, the money supply has been expanded by many trillions of dollars and yet there has been very little inflation because there are many heavily deflationary trends pushing in the other direction.

The critical thing to understand is that the national debt is basically an accounting gimmick. It never needs to be "paid off". It's a relic of ancient times when the government's money creation power was limited by the amount of gold it had. The debt only really serves to give people risk-fee savings opportunities. If the national debt were somehow paid off, we wouldn't have treasuries to save in.

Private credit is an interesting case since the risk-free nature of treasuries means that banks use them to get essentially free money and leverage themselves up, which can lead to instability. Private credit can expand and contract very quickly, leading to booms and busts which get bigger and bigger over time as the sheer quantities of money in play increase. When people borrow too much and want to de-leverage during the busts, it creates deflationary forces because paying down debt reduces the money supply. This is why the Fed has been able to create trillions out of thin air to finance government spending; it's just replacing all the bank-created money that's being destroyed by people paying down or walking away from their debts.

As to that article, it's just typical alarmist doomer porn. I wouldn't worry too much about it. If private credit contracts, government credit can expand to fill the gap. Of course, if governments hamstring themselves and fail to do so, then indeed there many be a painful period where society adjusts itself down to a more sustainable level of wealth.

[hoost]

Just read the article; his solution is an interesting one: keep printing money until it blows up.

We've had a few lengthy and at times heated discussions on the forum about the monetary system; I'm not sure if we have a cliff notes version of it.  I've been meaning to write an article or series of articles on how the system operates, based on the discussions we've had and the research I've done, but unfortunately I'm quite the procrastinator and I haven't done it yet.  I personally find the MMT paper to be unclear and confusing in certain areas, although I think his intentions are probably good.

I think Harry Browne's 99% of All You Need to Know About Money  (There is also an online version of the book that can be found via google, but I'm not sure if it's sanctioned by Harry's estate so I won't post the link here) is a good starting point.  I'd read that first and then ask questions from there.  There are several people on the forum who are rather knowledgable (with differing opinions) of the topic.

There was a very long discussion/debate on the topic in this thread: http://gyroscopicinvesting.com/forum/ht ... ic.php?t=7, but it may be more than you want to get into at this point.  Also, we've come to a lot more agreement as a result of that discussion and various other threads.  I believe the discussion starts around page 3.

I hope that helps.

[WildAboutHarry]

If you have never read it, Henry Hazlitt's Economics in One Lesson is a gem.  Considering it was written in the 1940s, it is remarkably fresh.

[hoost]

If you have never read it, Henry Hazlitt's Economics in One Lesson is a gem.  Considering it was written in the 1940s, it is remarkably fresh.

I'll second that.  HB also recommended this book and it's very well-written.

[Gumby]

Pointedstick pretty much nailed it.

Another good resource is...

http://paulgrignon.netfirms.com/Moneyas ... Credit.pdf

That short document — while by no means perfect — basically explains (in Cliff's Notes terms) how money and credit comes from debt. That's where money comes from.

However, Benko, the interview isn't totally wrong about things. The talking heads are saying that our government relies too heavily on encouraging private credit to spur growth. They argue that this eventually leads to instability, fragility and depressions. Duncan advocates increasing the National Debt considerably to fill the private credit hole and then suggests that this will only serve to create even more unstable private credit down the road. There is certainly some truth to that — it's one of the flaws of our debt-based/credit-based monetary system (since all money comes from either public debt or private credit). Though, keep in mind that he's trying to sell books about doom and gloom, so we have to recognize that anything can happen.

But, overall, I would say that a debt-based monetary system combined with a private credit-based monetary system is destined to cause increased fragility — as larger and larger boom/bust cycles happen over time within the private sector. Some would even say this is intentional.

[Ad Orientem]

In addition to the preceding excellent suggestions I will add "What Has The Government Done To Our Money" by Murray Rothbard. An audio version of the book can be found here...

http://www.youtube.com/watch?v=XLvrpWVH ... plpp_video

[Pointedstick]

One thing to keep in mind if you read Rothbard and Hazlitt (highly recommended, BTW) is that they're usually talking about general principles, while the stuff I mentioned earlier is from Cullen Roche and is more concerned with how the monetary system of the USA *actually* behaves. This isn't to say that the Libertarian/Austrian works aren't useful; they absolutely are, but you need to keep an open mind and understand that the conditions they assume are present may not all here today. Like the gold standard.

For example, many Austrian economist types claim that money printing causes inflation, but today we live in an era of massive money printing and low inflation. It's important to qualify that that money printing merely creates inflationary forces which can oppose deflationary forces to cancel each other out. That's how today we have both massive money printing as well as dramatic de-leveraging and falling prices in real estate, with the net result being near-zero inflation.

[BearBones]

But, overall, I would say that a debt-based monetary system combined with a private credit-based monetary system is destined to cause increased fragility — as larger and larger boom/bust cycles happen over time within the private sector. Some would even say this is intentional.

So, Gumby, you and others have clearly read a ton on this subject. Has it changed your investment behavior? Or do you stay agnostic and endorse near 100% HB PP?

[Pointedstick]

So, Gumby, you and others have clearly read a ton on this subject. Has it changed your investment behavior? Or do you stay agnostic and endorse near 100% HB PP?

It definitely has for me. I bought heavily into the "stocks always go up!" nonsense until I really grasped the nature of our monetary system and realized what a gamble it truly is. The fact of the matter is that Gumby is absolutely right: as time goes on, the shit in our system is going to hit the fan more frequently and harder. And which assets go nuts when that happens? long bonds and gold! The genius of the PP is precisely that it weathers these storms so well. When everyone else is freaking out because their stock-heavy portfolios are tanking, you can look at your gold and bonds going gangbusters, and your cash sitting safely and placidly.

If we had a more sane monetary system and a healthier private sector, the PP would probably suck. Why would you want gold or bonds if the economy was steadily growing nearly all the time? You'd be missing out on near-constant growth! But in the heavily-manipulated world we actually live in, sometimes the stock market panics and sets itself on fire. It's precisely because of the messy, imperfect nature of the real world that the PP responds so well.

[Gumby]

Well said, Pointedstick. I agree 100%.

So, Gumby, you and others have clearly read a ton on this subject. Has it changed your investment behavior? Or do you stay agnostic and endorse near 100% HB PP?

I'm agnostic and I fully endorse the 100% HB PP. The more I learn about our monetary system, the more convinced I am that the 4x25 is the best portfolio to weather whatever lies ahead — rain or shine.

[Benko]

Thanks everyone.  Not intuitive stuff.

[hoost]

So, Gumby, you and others have clearly read a ton on this subject. Has it changed your investment behavior? Or do you stay agnostic and endorse near 100% HB PP?

I'm agnostic and I fully endorse the 100% HB PP. The more I learn about our monetary system, the more convinced I am that the 4x25 is the best portfolio to weather whatever lies ahead — rain or shine.

I agree 100% with what you said there Gumby.

[MachineGhost]

"“When we broke the link between money and gold, this removed all constraints on credit creation. This explosion of credit created the world we live in, but it now seems that credit cannot expand any further because the private sector is incapable of repaying the debt it has already, and if credit begins to contract, there’s a very real danger that we will collapse into a new Great Depression,”? he argued.

A Depression isn't possible without decelerating trade, capital flight, brain drain or some kind of constraint interfering with free enterprise: http://en.wikipedia.org/wiki/Smoot_hawley

I grow eye-rolling bored with doomers always railing against the "explosion of credit".  Money is necessary for the economy to grow and function as the population increases, so there's nothing wrong with it.  They confuse excess leverage with credit.  They also confuse liquidity with insolvency: http://en.wikipedia.org/wiki/Recession# ... _recession

[hoost]

A Depression isn't possible without decelerating trade, capital flight, brain drain or some kind of constraint interfering with free enterprise: http://en.wikipedia.org/wiki/Smoot_hawley

I grow eye-rolling bored with doomers always railing against the "explosion of credit".  Money is necessary for the economy to grow and function as the population increases, so there's nothing wrong with it.  They confuse excess leverage with credit.  They also confuse liquidity with insolvency: http://en.wikipedia.org/wiki/Recession# ... _recession

I would argue that the Fed's manipulation of interest rates may qualify as something interfering with free enterprise.

I would also say that credit, leverage, and debt are different terms for the same thing.  Excess leverage means that people are holding too much debt, which means that too much credit has been issued.  A balance sheet recession happens when people realize that they over-valued the things that they own and took out loans against them. 

For instance, when someone saw their house appreciate from $200k to $400k market value and took out a line of credit to "unlock" the equity, and then the housing market crashed and now their house is worth $200k again, but they still have to pay back the line of credit.  They are unable to sell their house until they can pay back the debt on it.  Instead of working to consume more, they are working to pay back their past overconsumption, which means they are able to consume less now, which will drive down demand for luxury/consumer goods until the debts are repaid.  Depending on how much debt there is to repay, this situation may continue for an extended period of time, which could turn into a depression.  To me a depression is characterized by an extensive period of deleveraging/paying back debt, which reduces the money supply and causes a decline in economic activity as people's excess production is used to repay previous consumption.

I don't think you have to be a doomer to look at that situation and realize that it's going to take some time for people to get themselves out of debt.  It doesn't necessarily mean that everything will collapse, unless we continue adding to the debt until we're past the point that it can't be paid back anymore.  Even then, who knows what that point is, or how far past it we need to go?  I think it's important to recognize the situation, but I wouldn't worry much about it other than recognizing that it reaffirms the wisdom of the PP.  These same factors were in place when Harry came up with the allocation, but he recognized that even if we know the "what" and the "why", we don't know the "when".  So best to be prepared and stop worrying about it.

Sorry I got a bit long-winded there and probably off onto a tangent.  I don't have time to re-read what I wrote right now, so I'll just throw this post to the wolves.

[Pointedstick]

hoost, what's funny/sad is that if you think of a government policy in terms of what it "should" do to alleviate such a happenstance, you reach a pretty depressing conclusion: that the least bad option in the short-term is to bail out the indebted so as to clear up their balance sheets and get them spending again. Unfortunately, doing so acts as a huge incentive for further reckless indebtedness, increasing the likelihood of the government needing to do it again, and initiating a cycle of perpetual politically-motivated bailouts. On the other hand, what's the government supposed to do? Let people suffer and say things will eventually work themselves out at a permanently lower though more sustainable level of wealth? This may be true, but saying it or attempting to craft policy around it doesn't tend to win politicians any votes.

I think we already see this everywhere. People who are bailed out with some sort of federal intervention include big banks, insurance companies, auto companies, energy companies, mortgage-holding homeowners, student loan borrowers, money market fund owners, poor people, sick people, old people, and so on and so forth. Allowing companies and people to feel the pain of their bad decisions has become politically impossible, so we've become a permanent bailout society, with ever larger groups of people organizing politically to grab onto the federal money train.

I think it's quite clear that our political system greatly exacerbates the problems of the (politically-created) monetary system by encouraging bad behavior and trying to prop up peoples' expectations of being wealthier than they actually are. But hey, we all  have to live in the world around us, not the world we'd prefer, and what's the one portfolio that you can adopt to benefit from this really quite terrible state of affairs? I think we all know the answer to that! 

[Gumby]

Such is the nature of debt-based money. If everyone wants "money" to represent their own hard work (or future hard work), it has to come from either a national debt or a private form of credit. There is no other way to conjure money. And since interest must be paid on all debt-based/credit-based money, the private sector is always massively in debt to itself and the public sector's debt mainly serves to bailout the private sector's credit (as Pointedstick pointed out).

My 2¢... Debt-based/credit-based money is really just an elaborate mess designed to enslave, confuse and distract the masses from the wealthiest individuals who reap all of the benefits of the monetary system and do everything they can to keep it that way.