Gyroscopic Investing

Mdraf wrote: It's really not complicated at all.  It's all a big "circle jerk". You cannot create something out of nothing no matter how many web links you point to.

I think most of us would admit this, but we also try to understand it because it has an effect on how our investment portfolios behave. Nobody ever profited from remaining stubbornly ignorant.

We'll all admit it's a circle jerk mdraf, but what you aren't realizing is that the act of trading one fiat circle jerk asset for another fiat circle jerk asset amongst circle jerkers is not a fundamentally impactful event.

Treasury bonds are "almost" money at this point. They're like savings accounts at the fed.

The point isn't whether it or is not a circle jerk. It's identifying what is fundamentally happening, and how it might affect the private economy around it.

Similarly, on a micro scale, retirement account rules can be confusing, and choices around them can be unintuitive.  Instead of looking at the rules and complaining about them, we all try to understand them and bring ourselves to understand how to make decisions around them and how they'll fundamentally affect my balance sheet.

True T-Bonds are almost money because right now the US is still the world's largest and strongest economy, NOT because we can print our own currency. Many countries print their own currency and nobody wants their bonds. That is the "value" behind US T-bonds. If our economy crashed to the point where the Government is unable to collect taxes because there aren't any to collect, T-bonds would be worth the same as Greek ones.

Yes. Similarly, if Google crashes and burns, Google bonds are going to be worthless. That's just how bonds work. They're all premised on trust that the issuer--whoever they are--will have the productive capacity to keep servicing the debt.

For firms, this is their profitability. For governments, this is the productivity the their economy they control. Greece only needs to tax because they don't control their currency and can't print Euros, so their bonds are backed quite directly by their ability to tax their people. But a country like the UK or Japan or the USA that is a currency issuer, not a currency user, may have the same fundamental constraints of a productive economy, but they have more wiggle room in the short term. Being able to print money doesn't exempt currency issuers from needing a productive economy able to sustain the payments to the bondholders, it just lets the flow be a bit more flexible and indirect.

TennPaGa wrote:

AdamA wrote: The overall concept makes sense to me, but I think I would understand even better if I understood what happens to make this type of fiat system sick.  What happened in 2008, exactly?  How would the balance sheet in this example look then (2008) and also after some the interventions we've tried?

I've been trying to understand this myself lately.  Here is where I'm at right now:

I would say that the system got sick because things that banks *thought* were near-liquid assets, like mortgage-back securities, turned out not to be as liquid as they thought, and also not worth as much as they thought.  Banks' natural response to this "holy crap" moment was to hold more reserves.  However, banks primarily exist to facilitate money exchanges in the economy.  The fact that they were tying up more in reserves to back these toxic assets meant less was available for the normal money exchanges.  And so the system needed more liquidity to avoid freezing up.  TARP provided this by buying the assets for reserves supplied by the Fed.  As with QE, the net financial assets of the private sector banks did not change, only the composition of those assets -- the "moneyness", to use one of Cullen Roche's terms.

Again, I'm not sure this is exactly right, and there are probably lots of details I'm missing.  However, I like to understand things at a high level without getting bogged down in details.  The trick, of course, is figuring out which details are necessary and which aren't.

This is all generally correct. But when you get right down to it, the system really got "sick" because of private credit issues.

This most important thing to understand in our monetary system is that all money (except coins) comes from either public debt or private credit. The second most important thing to understand is that the overwhelming majority of the money supply is actually private credit. In our debt-based/credit-based fiat monetary system, both of these tend to grow somewhat exponentially, with a few exceptions (such as defaults and bad loans within the private credit system, etc.). So, the money you "earned" in your bank account either came from government deficit-spending (i.e. the government borrowed the money into existence) or it came from someone else going into debt (i.e. a corporation borrowed money from a bank to pay an employee who then paid you). And since there is interest to pay on that private credit or public debt, the private credit and public debt tends to snowball a bit — people and corporations on a Macro level take out more loans to pay off their previous loans. So, it's all debt (except the coins, which are technically a form of "debt-free" money). This is how bankers designed the overall system, knowing that all these debts would snowball over time in their own vaults.

This concept of debt-based money is important to understand because, imagine you have a situation where an extraordinary amount of private credit is being issued, irresponsibly, that can't possibly be paid back. What happens? Well, the private sector starts defaulting on its own private credit. And when that happens, a large portion of the credit-based monetary system — that everyone uses to pay bills and buy things with — starts to rapidly disappear. That money that a creditor is owed isn't paid back and the system has to figure out how to function with the missing credit payments. But, it doesn't.

That is the easiest way to describe a "Balance Sheet Recession" — which is what happened during the 2008 credit crisis. It was a giant Balance Sheet Recession. And the same thing hit Japan a few decades earlier. It's a giant private credit hole.

The thing about a Balance Sheet Recession is that the quickest way to repair the balance sheet is to supplement the private credit hole with money created from public debt — tax breaks or deficit spending, or both. Either way, if you want to quickly "fix" the symptom (and maybe your politics dictate that you don't want to interfere, that's your own choice) the government needs to fill the private credit hole with its own debt-based money. And that's what happened. The government jumped on the toxic asset grenades (the Fed "swapped" them for cash) and the government spent its currency into existence by issuing government debt.

Most critics of the Fiscal and Monetary policies wrongly assumed that this was going to create massive inflation. But, those individuals did not understand that A) The Fed doesn't really have the power to create massive inflation, since it only conducts "swaps," and B) while the Treasury can create inflation (via Congress), if the private credit hole was larger than the amount being spent by the Treasury, the net result would still be some deflation — since the private credit hole was so large.

In other words, since the overwhelming majority of the money supply is private credit, you can't determine anything about the money supply without looking at the size and health private credit first. Government-issued money really pales in comparison to the private credit market. I believe the private credit market is roughly $57 trillion and government deficit spending is roughly $16 trillion. Anyway, you get the idea. It's all about private credit and government-debt can stimulate and supplement the private sector's own credit-based money supply.

If our country crashes so far to the point where our bonds have problems, so will our currency. Further, aren't Austrians operating under the premise that rates are unnaturally low as a result of fed easing?  In this world, why would we either have a tax problem or a bond problem?  It would just be a currency problem.

And as your post alludes to, it would take a fundamental collapse of our productive capacity.  Our recession isn't a collapse of productive capacity, but a collapse of the private sector's ability to want to use that capacity.  Very, very different animals.

Mdraf wrote:Many countries print their own currency and nobody wants their bonds.

The countries you are referring to either owe foreign-denominated debt (in which case no amount of printing will save them) or they are war-torn or have pegged their currency to another. Those are not the kinds of countries we are discussing.

A country that prints its own currency, owes no foreign-denominated debt, does not spend beyond its productive capacity, and is not involved in a brutal war has no trouble selling its own bonds because only the very currency it issues can be used to buy those bonds. In other words, you can't buy Japanese bonds with US Dollars (you need to swap currencies first). So, the demand to buy those bonds is directly determined by the amount of fiat cash in existence for that particular currency.

A country like Greece has a problem because A) it can't issue its own currency and B) the bonds it sells to spend Euros into the Greek economy can be used to buy German or French bonds and nobody has to buy Greek bonds with those Greek-issued Euros to get a government-backed return. In other words, the Greek government is very much like a US State that doesn't have a Federal entity spending money into it (a bad idea).

A country like Zimbabwe has a problem because they have spent way beyond productive capacity and people have no reason to trust the government any further. So, they have no desire to "save" their currency (as bonds) and stop using the currency.

Therefore the US does not have a monopoly on safe bonds. It just comes down to finding a country that satisfies the above requirements — such as Japan, the UK, or Australia, etc.

Gumby wrote: A country like Zimbabwe has a problem because they have spent way beyond productive capacity and people have no reason to trust the government any further.

I think the racist land redistribution policies and other economy-destroying follies had a bigger impact. In other words, the government didn't spend beyond its economy's means, it destroyed its economy's means and then kept on spending. Subtle distinction, but I think it matters.

Pointedstick wrote:

Gumby wrote: A country like Zimbabwe has a problem because they have spent way beyond productive capacity and people have no reason to trust the government any further.

I think the racist land redistribution policies and other economy-destroying follies had a bigger impact. In other words, the government didn't spend beyond its economy's means, it destroyed its economy's means and then kept on spending. Subtle distinction, but I think it matters.

Interesting. Good point! (I was just looking for a generic irresponsible country).

AdamA wrote:

TennPaGa wrote: [New Economic Perspectives: Playing Monopolis Money

Also a great link.  The comments are informative too.

The overall concept makes sense to me, but I think I would understand even better if I understood what happens to make this type of fiat system sick.  What happened in 2008, exactly?  How would the balance sheet in this example look then (2008) and also after some the interventions we've tried?

There's two kinds of money.  Base money (or outside money (reserves, dollars and coins), and credit money (inside money (loans, essentially.. Leverage).

Credit money is at its healthiest when it's linked to true investment, not a flat screen tv, so the nature of the loan matches the nature of the long term value produced.  This kind of money creates a liability with it, so it's inherantly fragile if debt is gone into for malinvestment.  Like way too big a house or a super fancy car you can't afford.  Credit money needs to be tied to a) true long term value, and b) ability to pay to remain healthy.  Think of credit money, instead of being backed by gold or nothing, as being backed by some real asset in the economy, whether a car, a tv, or (hopefully) a factory building a better widget.  The loans will literally often act as a claim on those assets if they aren't repaid.  Sorta like a gold standard, but a differen kind of asset underlies it and claiming it might not be as easy as a gold window at a bank.

Treasury bonds, it should be noted, are much more similar to cash than they are to a loan in the private sector, as there is no cash strapped entity with a home as collateral. Just the government, who'se rigged the game to make sure your bond is as good as cash.

Base money works great as "clearing money," which can be used to pay off debts without incurring new ones, or it can be used to consume the end consumer goods in the economy.

To maximize productivity in an economy, you want a good ratio between the underlying productive capacity of the economy, the credit money that requires sound investment to acquire, and the base money that can act as lubrication and cushion to all the private lending that goes on.

If you have an economy built a lot of investment linked to credit money, but not enough clearing money in the economy, a shock can come and totally lock up the machine. That was 1929 or 2008.  It doesn't mean there weren't some fundamental problems with the assets that people were linking credit money to, but the lack of base "clearing money" exacerbated the problem when housing or the stock market took a huge hit.

The nice thing about credit money is that you usually have to invest in something of real value to get it at a rate that any reasonable person could consider attractive.  This incentivizes investment. So if an economy were to be built on a very anti-credit system, it would be difficult to procure the funds to build a widget factory, and we just have a bunch of base money floating around out there with little investment in production, which leaves you prone to inflation and limits wealth creation.

So you need a mix. The private sector needs enough base money and credit money, in balance, to have the financial machine work so that investment occurs, as does production, but if you have an economic shock, the economy has enough clearing assets that it doesn't seize up.

moda0306 wrote: So you need a mix. The private sector needs enough base money and credit money, in balance, to have the financial machine work so that investment occurs, as does production, but if you have an economic shock, the economy has enough clearing assets that it doesn't seize up.

Exactly.

Here's a chart of US total private credit (inside money):

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...And here's a chart of the US National Debt (outside money):

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Notice how the public debt (outside money) was increased in response to the stall in private credit? That's what happened!

Outside money replaced the vacuum in the inside money.

(Keep in mind that the scale in the charts are very different, so a large jump in the National Debt was needed to create a small dent in private credit.)

Gumby wrote: Ultimately what you are probably wondering is if whether the money supply increases when the Fed buys bonds. The answer is here:

http://pragcap.com/does-the-money-suppl ... ys-bonds-2

Cullen Roche wrote:Like any bank, the Fed can create money “from thin air”?.  This is how it creates reserve balances to transact monetary policy.  It has always done this.  For instance, in 2006 reserve balances increased by $50B at member banks as the Fed implemented policy, but no one complained about “money printing”? and “debt monetization”? back then.  In other words, this is ALWAYS how the Fed implements policy.  But QE has caused a great deal of confusion, thanks in large part to the neoclassical confusion regarding the definition of the “money supply”?.

When the Fed purchases bonds they are simply changing the composition of the bank balance sheets...

...It’s important to note that the net financial assets of the bank are exactly the same after QE as they were before.  In other words, the bank has experienced no change in its balance sheet except the composition.

Source: http://pragcap.com/does-the-money-suppl ... ys-bonds-2

Simply changing the composition of a bank's balance sheet is an example of "monetary policy". Spending money on an aircraft carrier would be an example of "fiscal policy" and that would come from the Treasury. In other words, the Treasury is usually the entity that has the greatest effect on inflation. The Fed, on the other hand, is fairly impotent when it comes to creating inflation.

Another great link. 

So all QE really does is attempt to encourage banks to loan by exchanging non-interest bearing monies (reserves) for interest bearing Treasury bonds? 

From the link:

The way banks create money is quite simple.  When creditworthy customers walk in their doors they issue loans which create deposits and find bank reserves (as required) later. 

What determines the reserve requirement?

AdamA wrote:So all QE really does is attempt to encourage banks to loan by exchanging non-interest bearing monies (reserves) for interest bearing Treasury bonds? 

From the link:

The way banks create money is quite simple.  When creditworthy customers walk in their doors they issue loans which create deposits and find bank reserves (as required) later. 

The quote you are referencing is saying that banks aren't reserve constrained. They make the loans and then find the reserves later with no problem. So, even though the media often said that an increase in reserves should make banks more willing to lend, it didn't because the demand for loans was the problem (again, the banks were never reserve constrained in the first place).

The media suggested that QE made it easier to loan, but since the banks were never reserve constrained, it really didn't make a difference.

QE did the following (I am over-simplifying):

- Lowered rates (in hopes to make loans more enticing for consumers and businesses).
- Reduced the amount of T-Bonds in the private sector. Since T-Bonds were more scarce, this lowered rates and made people more likely to bid up assets (such as gold and stocks) with cash as they passed their cash around like a hot potato.

So, it didn't really do anything substantial beyond making people click a lot of mouse buttons as they bid up assets. But, if you think about it, that's not how you create lasting changes in an economy. The changes are pretty temporary and short term, but the hope is that it would help jump-start the economy a bit.

AdamA wrote:What determines the reserve requirement?

The Fed determines this as part of their Monetary Policy. It's not really important for this discussion since some countries don't even have any reserve requirements.

AdamA wrote:...by exchanging non-interest bearing monies (reserves) for interest bearing Treasury bonds? 

That that is the flaw in the whole discussion. They have nothing of value to exchange it with, so they "print" (create with keyboard) money.

Mdraf wrote:

AdamA wrote:...by exchanging non-interest bearing monies (reserves) for interest bearing Treasury bonds? 

That that is the flaw in the whole discussion. They have nothing of value to exchange it with, so they "print" (create with keyboard) money.

How is that a "flaw"? ...Just a moment ago, you said:

Mdraf wrote:True T-Bonds are almost money

So, if the government swaps "almost money" for printed money, it's a basically a non-event for the private sector. Nobody in the private sector feels any richer or poorer after the fact.

If anything, the private sector lost its interest-bearing assets so the private sector is probably worse off after the exchange.

Gumby wrote:

Mdraf wrote:

AdamA wrote:...by exchanging non-interest bearing monies (reserves) for interest bearing Treasury bonds? 

That that is the flaw in the whole discussion. They have nothing of value to exchange it with, so they "print" (create with keyboard) money.

How is that a "flaw"? ...Just a moment ago, you said:

Mdraf wrote:True T-Bonds are almost money

So, if the government swaps "almost money" for printed money, it's a basically a non-event for the private sector. Nobody in the private sector feels any richer or poorer after the fact.

If anything, the private sector lost its interest-bearing assets so the private sector is probably worse off after the exchange.

As I said in another thread T-Bonds have value in so far as they are backed by the market's faith in future repayment based on tax collection. The Fed has no such powers so the money they create is backed by nothing. So it is not an even "exchange".

And yes, the private sector IS worse off after the exchange. No individual feels worse off but collectively there is now more money in the private sector that is (in its totality) worth less than before.

I agree that Greece is a bad example. A better example would be Britain after WW2.  As its empire disintegrated so did the pound. Before WW2 the Pound was the world primary currency as is the dollar today.  When Britain embarked on massive social programs it went into huge debt.  At the same time their tax base was shrinking as businesses no longer had the Empire to absorb their exports.  So despite the fact that they printed their own currency their bonds became junk and the Pound collapsed from $5 to $1.50.

TennPaGa wrote:

Mdraf wrote:

AdamA wrote:...by exchanging non-interest bearing monies (reserves) for interest bearing Treasury bonds? 

That that is the flaw in the whole discussion. They have nothing of value to exchange it with, so they "print" (create with keyboard) money.

Since the discussion is about the mechanics of the system, I don't see how a factual statement (exchanging non-interest bearing monies (reserves) for interest bearing Treasury bonds) can be a flaw in the discussion.

In any case, if you indeed think this money has no value, would you be willing to send me 100 of these (I can recommend some places to obtain them):


I'll send you 100 1000 of these in return:


I'll even pay the postage!

That's not what I'm saying. That $100 bill the Fed just printed in exchange for the T-bill made the one in my pocket only worth $99.99999

Gumby wrote: The quote you are referencing is saying that banks aren't reserve constrained. They make the loans and then find the reserves later with no problem.

So what determines what the required reserve is?

Gumby wrote: The thing about a Balance Sheet Recession is that the quickest way to repair the balance sheet is to supplement the private credit hole with money created from public debt — tax breaks or deficit spending, or both. Either way, if you want to quickly "fix" the symptom (and maybe your politics dictate that you don't want to interfere, that's your own choice) the government needs to fill the private credit hole with its own debt-based money. And that's what happened. The government jumped on the toxic asset grenades (the Fed "swapped" them for cash) and the government spent its currency into existence by issuing government debt.

So if I borrow $100 from a bank and I go buy real things on the economy and then can't pay the bank back the Fed can step in and "swap" cash for my bad loan?  The bank is okay, but the Fed is then basically stuck with a bad IOU from me. 

How are we able to do that?  Is it simply b/c we have such vast resources? 

Mdraf,

Where are you getting this idea that a bond is backed by future taxation?  Has anyone of reason since 1972 viewed a treasury bond as backed by future taxation?

That's the big cheat, Mdraf... it happened 40 years ago.  However, we still had a productive economy, and taxes to stimulate some demand for our money, so the whole damn thing didn't unravel.  You can't claim that treasury bonds are manipulated instruments, and then cry wolf every year they're manipulated trying to re-prove your point.  We've fundamentally changed the nature of the treasury bond market into something much more akin to the "government savings account" example I gave you before.

Also, at the first sign of higher inflation the fed can "unprint" the money.  You could never do that if it was a true helecopter drop.  People would have the money and unless you taxed it away from them you'd never be able to get it back.  However, they take one of their circle-jerk certificates back into the frey (t-bond) and buy their money back.  So the M0 isn't even permanent, and the market knows that.  How do we then look at money supply?  It's not like gold where once it's mined your "M0" can't really go lower (unless Goldmember succeeds at his plot).

So just looking at base money supply (M0) in a vacuum is a hugely misleading habit.  Even M1, M2, and M3 don't complete the circle, because T-Bills might as well be money for the purposes of how people view their savings.


The government and member banks are basically just score keepers at this point... and whether those "points" are kept in bonds or dollars is irrelevant, because we know the game they're going to play between the two... they'll never let the government go bankrupt (so the bonds will get repaid), and any rampant inflation will get buffered by the fed (by removing "excess M0" from the system).  This is fundamentally different than a fixed-but-maybe-growing-depending-on-mining-activity M0 in the form of gold, and the government having to enter the free market for whatever it can't get in taxes and borrow that gold from people.

Two fundamentally different systems.  They both might look the same to some (football vs rugby), but pretty quick you'll realize if you try to play one like the other you're going to lose real fast.

Mdraf wrote:As I said in another thread T-Bonds have value in so far as they are backed by the market's faith in future repayment based on tax collection.

Not even remotely true. The repayments are made with additional bond issuance. Tax collection only accounts for a small portion of government spending.

Additionally, you don't even consider where money comes from. All money (except coins) comes from private credit or debt-issuance. So it's impossible to say that tax collection backs anything when the money to pay taxes comes from debt-issuance or private credit in the first place. It's all debt.

Gumby wrote:

Mdraf wrote:As I said in another thread T-Bonds have value in so far as they are backed by the market's faith in future repayment based on tax collection.

Not even remotely true. The repayments are made with additional bond issuance. Tax collection only accounts for a small portion of government spending.

Additionally, you don't even consider where money comes from. All money comes from debt-issuance. So it's impossible to say that tax collection backs anything when the money to pay taxes comes from debt-issuance in the first place!

Additional bond issuance is in turn secured by more future taxation. Tax collection comes from productivity and nothing else.

Mdraf wrote:

Gumby wrote:

Mdraf wrote:As I said in another thread T-Bonds have value in so far as they are backed by the market's faith in future repayment based on tax collection.

Not even remotely true. The repayments are made with additional bond issuance. Tax collection only accounts for a small portion of government spending.

Additionally, you don't even consider where money comes from. All money comes from debt-issuance. So it's impossible to say that tax collection backs anything when the money to pay taxes comes from debt-issuance in the first place!

Additional bond issuance is in turn secured by more future taxation. Tax collection comes from productivity and nothing else.

Wrong. A fiat government doesn't even need taxation. By definition, a fiat government cannot run out of money and is never rich or poor from a monetary standpoint. What you are describing hasn't existed since 1972.

Furthermore, a fiat government doesn't even need bonds. Ipso facto, your argument is a non-sequetor.

Ok people. I received several pm's saying I'm wasting my time debating this with the MR/MMT ers.  I will desist with one last statement.
Economics is very simple. It is nothing more than common sense and human behavior. From the days of swapping arrow flints for bearskins to the 21st Century "New Normal" nothing has changed.