Poll: Which class should perform falling off the fiscal cliff?

[Pointedstick]

My apologies, Kshartle. I erroneously assumed that by saying, "If you really consider FRNs money", you were implying that they are not, a position I associate with people asserting that only gold is money.

As to your question, the answer requires a bit of explanation. Let's first go back to the gold standard and re-ask it. Under a gold standard, when the treasury prints a dollar bill, they have not created value out of thin air; rather, the dollar is a convenient unit of measurement for value that already exists--some quantity of gold. And that gold has value because it buys some quantity of goods and services in the economy.

When the currency ceases to be backed by gold, those dollars no longer denote some quantity of gold. Rather, under a debt-based monetary system (which we live in), they represent the value of a promise: the promise of the debtholder to repay the debt associated with the dollar. If the dollar was created by a bank, the promise is embodied in a mortgage, CD, car loan, credit card, etc. If the dollar was created by the federal government, it's their promise to repay the holder of the treasury bond that backs it. Though the dollars stand for debt and not gold, the underlying value is still the value of the goods and services in the economy. In this case, the debt backing the dollar has already been used to buy those goods and services.

A fiat paper currency is useless in and of itself. Its value is always inherently coupled to the value of the goods and services in the economy. The money just exists as a convenience to track and exchange that value.

[Kshartle]

Again this is getting way off topic. No one else is talking about the gold standard. The concept of what money is debatable and somewhat a matter of opinion. Shells can money, salt can money...etc etc. Like Browne wrote he said in all his studies paper has never been money, just a money substitue. At any rate that's not the point here, we're not on the gold standard so let's not keep getting off the topic.


By printing dollars they have not created value. Therefore there is no additional purchasing power in existance. The FED does have additional purchasing power though. It came from the decreased purchasing power of others. I'm sure you'd agree if they created 50 trillion dollars that individual dollars would be worth a lot less relative to everything else. What's true for 50 trillion is true for 1 trillion or $1.00

The point of all that is......when we go over the "cliff", if Government expenditures are just as high as last year or higher, and they aren't able to acheive more revenue through higher rates because human beings make rational decsions to change behavior to minimize taxes (which they will surely do) the Government will have to find another way to steal the purchasing power to fund it's operations. My guess is it will be through the stealth inflation tax (gives the added bonus of blaming "greedy corporations"). I think the FED has announced it will print over 1.1 trillion next year. I think they will have to print several hundred trillion more to loan to the Government which will cause downward pressure on the dollar, devalue the bonds in real terms and cause other players in the market to demand higher rates. They might not get higher rates but at some point the FED becomes the only buyer or the bond market collapses.

Of course something totally different could happen.

Maybe Aliens will appear and we'll be able to sell them 30 year treasuries.

[Bean]

What are you talking about? You're creating a strawman argument to knock down, certainly not one that was part of the discussion thus far.

The point is you can't create something of value out of thin air. You can't do it and neither can the FED. They can create FRNs. If those FRNs have value then it must have been taken from somewhere else. Where did the value come from?

Gold = Money = (1) durability, (2) divisibility, (3) transportability, and (4) noncounterfeitability.

Federal Reserve Notes are a fiat currency, so they fail the durability test.  So technically FRNs are a currency, or just medium of exchange, not a store of value like money.

Basically this means the FED can create notes or currency (not value) at any time and there is zero need to have any sort of value behind it, other than faith.

[Pointedstick]

The Fed prints dollars, but it doesn't just hand it out or drop it from helicopters, it uses those dollars to buy treasury bonds from the Treasury, or, in crazy situations, bad loans from banks. In ordinary times, if Congress ran a balanced budget, the printing presses in the Fed's basement would be sitting idle.

If the private-sector-created money supply (i.e. bank loans) remained static and the Fed created $1 to buy a $1 bond that the Treasury issued to pay for a $1 expense that congress appropriated, then yes, the money supply has been devalued by $1.

But what happens if the private money stock is rapidly shrinking because people are paying down or defaulting on their debts, and banks aren't making new loans? Then you have the private component of the money supply rapidly shrinking. Absent Congress/Fed action to grow its half of the money supply by an equal amount, the result will be deflation, unless GDP is also shrinking by the same amount.

The take-home point is that in this kooky, cockamamie public/private debt-based monetary system we have, private banks and Congress/The Fed have to work together to balance each other out to ensure a stable money supply. If one side stops creating debt or sees its debt paid down or defaulted on, the other side needs to compensate or else the result will be deflation. Similarly, if one side is rapidly expanding its debt creation far in excess of GDP growth, the result will be inflation unless the other side slams the brakes on its own debt creation.

You're worried about the Fed printing 1.1 trillion dollars next year… what if I told you that the private money supply was contracting by that amount or more?

[Kshartle]

That's a good summary of how I feel about money also Bean. When I said it's a matter of opinion it's because some people asign a different meaning to the word and aren't as strict with their requirements. For them FRNs are money and the FED can thus create money. Ok, I can live with that as someone's opinion even if I disagree. But you can't create value by printing it. Something else has to be at work. You have to be able to force people to value what you've created number 1. Number 2, there's no added purchasing power, it's just been transferred to the FED who promptly transfers it to the Government by purchasing bonds through and intermediary.

[Peak2Trough]

You're worried about the Fed printing 1.1 trillion dollars next year… what if I told you that the private money supply was contracting by that amount or more?

Or that banks refused to lend it... or that people refused to borrow it... or that borrowers refused to spend it.

Pointedstick is right on the money here (pun intended).  Inflation isn't some magic phenomenon that occurs the minute the Fed adds to the money supply.  It just doesn't work that way, which is why the inflation hawks have been so tragically wrong for 4 years running...

[Pointedstick]

Kshartle, I think I see what the problem is. Your mental model is one of an essentially static money supply that the Fed artificially expands, thereby debasing the purchasing power of each monetary unit.

This would be absolutely true… if absent the Fed, the money supply was essentially static. But in the world we live in, the non-Fed part of the money supply is called the private banking system and the monetary base originated at the banks is constantly expanding and contracting as the banks issue loans, receive payments on previously issued loans, and write off defaulted loans.

Let's suppose that the private banking system freezes up and the balance of loans dramatically falls virtually overnight, say, by $3 trillion. Maybe there was a housing crash and millions of people defaulted on their smelly mortgages that Congress encouraged them to take on–whatever. It could be any kind of mass default on private debt. Now let's say Congress appropriates $1.5 trillion, finds no buyers (!!!), and the Fed prints 100% of the dollars necessary to buy them.

Now let's tally up what's happened to our money supply. We have a 3 trillion dollar subtraction on the private banking side, and a $1.5 trillion addition on the Fed side. Are those $1.5 trillion Fed-originaled, Congress-appropriated dollars actually very inflationary if they're equal to only half the amount lost in the private monetary base?

So the Fed is perfectly capable of creating inflation, but only when the private banking side of the money supply is static or also expanding. When it's contracting, the Fed can print up all the dollars Congress demands, but if it doesn't match the amount lost in the private banking system, it doesn't create inflation.

[mmaurice]

Unless I missed it somewhere, the real reason we can continue to print money and carry indefinite debt is military might.

Our military is bigger, stronger and more effective than the rest of the world.

The fear that should be in everybody's mind is China military might. They get it together over there and we have a real problem.

[Bean]

Unless I missed it somewhere, the real reason we can continue to print money and carry indefinite debt is military might.

Our military is bigger, stronger and more effective than the rest of the world.

The fear that should be in everybody's mind is China military might. They get it together over there and we have a real problem.

I was under the impression the constitution charges the federal government to have a well regulated militia for the defense of the nation and the majority of our annual budget goes to entitlements.

[Kshartle]

the Fed can print up all the dollars Congress demands, but if it doesn't match the amount lost in the private banking system, it doesn't create inflation.

Agreed.

I'm fully aware that bank loans create additional dollars and the subsquent payment retires or removes them from the money supply.

The FED has vowed to fight deflation. I take them at their word. They might not be nimble enough to stave it off in the near term but will intervene with additional bond purchases to re-inflate...until they stop.

They've promised to print 95 billion a month until the economy improves and then keep printing afterwards. They've said they're going to ignore rising prices as long as they think temporary inflation will subside. I take them at their word.

They can create an unlimited sum. They don't need the government to run a deficit to do it. There is no amount of deleveraging that can stop them from expanding the money supply if they choose too.

I expect at some point we will have a massive deflation in dollar terms. I think it will take a major currency crisis to get us there and the brink of hyperinflation (which I expect them to avoid). Until then I think the deflation in gold terms (increased demand relative to supply) will continue.

We could see another 2008 in 2013 and gold might drop 30%, stocks by +50% but my bet at that point would be a blast of trillions from Bernanke. Maybe he'll even get in the helicoptor.

Sorry if I sounded insulting at any point. I didn't mean to.

[craigr]

Ok we went over the dreaded cliff! Basically in total not much really happened. But looks like we got a stock bump overall which nobody but one person picked. Bonds, the most popular answer, declined…

Here are the results:

[Xan]

I thought what happened was that we DIDN'T go over the cliff.  Am I wrong?

[possum]

We technically went over the cliff, but not really in terms of anything that matters.

I don't think it is valid to compare anyone's predictions about what would happen if we went over the cliff based on what actually transpired.

[craigr]

The whole fiscal cliff issue was just to make news. It was pretty irrelevant on the date because I think most people making decisions about taxes in corporations, etc. know that it was a hurry up and wait issue. There is really nothing to be done because it's all in flux and I think most people suspected some kind of deal would be made. Until that deal comes out, there is simply no way to make an accurate analysis of how to react.

So my prediction was the markets already priced the uncertainty in and nothing would really happen. In total in terms of the Permanent Portfolio, that's pretty much what transpired. Total value was barely moved over the last few days of the year…

[MediumTex]

The fear that should be in everybody's mind is China military might. They get it together over there and we have a real problem.

Really?

Why would we have a problem if China had a stronger military?

I don't recall any period in Chinese history where the Chinese had a desire to project military power much beyond its border states (none of which are anywhere near the U.S.).

If we were really troubled by increasing Chinese wealth that may be used to enhance their military capability, it seems like we would just place a trade embargo on all Chinese-made goods.  I don't hear anyone calling for such an action, however.

I used to work at an office and our FedEx guy started taking steroids and I literally watched him go from about 160 pounds to about 230 pounds with almost no body fat over an 18 month period.  It was amazing.  You know what, though, I never feared him because I knew that the purpose of his increased strength would only benefit us because it would allow him to deliver more packages to us more quickly.  That's how I see the U.S.-China symbiotic relationship.  The strength of their military reflects the strength of their economy, and the strength of their economy reflects the strength of the U.S. consumer, which is good for us, not bad.

[Peak2Trough]

So my prediction was the markets already priced the uncertainty in and nothing would really happen. In total in terms of the Permanent Portfolio, that's pretty much what transpired. Total value was barely moved over the last few days of the year…

Except that we didn't go over the cliff.

You're saying that the markets knew for certain we would not do so and therefore priced risk appropriately for that eventuality?  How does that explain today's move, in your mind?

[craigr]

So my prediction was the markets already priced the uncertainty in and nothing would really happen. In total in terms of the Permanent Portfolio, that's pretty much what transpired. Total value was barely moved over the last few days of the year…

Except that we didn't go over the cliff.

You're saying that the markets knew for certain we would not do so and therefore priced risk appropriately for that eventuality?  How does that explain today's move, in your mind?

I think that there was no cliff really because taxes are not immediately paid on January 1st so in actuality there is more time to work things out. So the deadline was really just something the news was making a big deal out of. Plus there is good chance that there will be retroactive ways to avoid paying increases, etc. It's just way too fluid…

Today's move could simply be that it's the first trading day of the year and a lot of funds, etc. are doing purchases. It's just hard to say what would cause it in totality.