Gyroscopic Investing

Here we go... A much better explanation:

http://pragcap.com/understanding-the-fe ... ry-purpose

moda0306 wrote: MT,

The fed is more than the banker.  If I could do what the fed does I'd be banker every time in that confounded game.

I just mean that the entire arrangement has no underlying reality.  It's almost completely abstract.  It's just a bunch of numbers being moved from ledger to ledger.

In the unlikely event that the banks were to get caught with their pants down like they did in 2008, the Fed will be there to make sure that all of the numbers continue adding up (if you're a big bank, that is).

Gumby wrote: Here we go... A much better explanation:

http://pragcap.com/understanding-the-fe ... ry-purpose

So basically all the Fed really does is either shifts reserves around between different banks or trade them (reserves) for treasury bonds of varying duration.

That's pretty much it, right? 

AdamA wrote:

Gumby wrote: Here we go... A much better explanation:

http://pragcap.com/understanding-the-fe ... ry-purpose

So basically all the Fed really does is either shifts reserves around between different banks or trade them (reserves) for treasury bonds of varying duration.

That's pretty much it, right?

Bingo!

And as you can see, it's a real challenge for the Fed to create inflation if that's all it can do. It can't really make the private sector richer or poorer so it has to get very creative with its monetary policies if it wants to have any effect.

"Money For Nothing, And Your Chicks For Free" - Dire Straits

http://www.mindcontagion.org/fed/createmoney.html

Mdraf wrote: "Money For Nothing, And Your Chicks For Free" - Dire Straits

http://www.mindcontagion.org/fed/createmoney.html

That article is mostly correct. The only thing wrong is that banks aren't reserve constrained. Bankers don't sit around lamenting lost loans because they didn't have the reserves. No, they make the loan and then find the reserves later if they need to.

http://pragcap.com/banks-are-not-mystical

Cullen Roche wrote:Bank lending is not reserve constrained (in fact, many countries don’t even have reserve requirements at all).  This means that banks do not need reserves before they make loans.  Instead, banks make loans first and obtain reserves in the overnight market (from other banks) or from the Fed after the fact (if needed).  New loans result in a newly created deposit in the banking system.

Source: http://pragcap.com/banks-are-not-mystical

Other than that, the article Mdraf linked to just confirms everything we've already been saying. The article also points out that the Fed cannot create any money unless the T-bonds exist in the first place. In other words, our money is "debt-based" — our money is borrowed into existence.

Therefore, if all money is borrowed into existence (except coins, which are "debt free" money) it's impossible to suggest that bonds are backed by future taxation since all money comes from debt in the first place!

Yes, taxation gives the currency legitimacy and demand (i.e. you need the currency to pay your taxes). However, the key difference is that the government does not need taxation to pay future bond coupons (again, since the currency is technically debt-based and the money to pay future taxes can only come from future debt/credit). The government just needs taxation to create demand for the currency.

You could also say our money is backed by the might and force of the US military.

Gumby wrote: The only thing wrong is that banks aren't reserve constrained.

Actually if you click on the link in that article it takes you here:
http://www.mindcontagion.org/html/fract ... nking.html

Mdraf wrote:

Gumby wrote: The only thing wrong is that banks aren't reserve constrained.

Actually if you click on the link in that article it takes you here:
http://www.mindcontagion.org/html/fract ... nking.html

And that would all be true, if it mattered. But it doesn't, since banks aren't reserve constrained now...

Wikipedia.org wrote:Effective December 27, 1990, a liquidity ratio of zero has applied to CDs, savings deposits, and time deposits, owned by entities other than households, and the Eurocurrency liabilities of depository institutions. Deposits owned by foreign corporations or governments are currently not subject to reserve requirements.

When an institution fails to satisfy its reserve requirements, it can make up its deficiency with reserves borrowed either from a Federal Reserve Bank, or from an institution holding reserves in excess of reserve requirements. Such loans are typically due in 24 hours or less.

An institution's overnight reserves, averaged over some maintenance period, must equal or exceed its average required reserves, calculated over the same maintenance period. If this calculation is satisfied, there is no requirement that reserves be held at any point in time. Hence reserve requirements play only a limited role in money creation in the USA.

Source: https://en.wikipedia.org/wiki/Reserve_r ... ted_States

Furthermore, even the Fed has admitted that the money multiplier is a myth:

http://www.federalreserve.gov/pubs/feds ... 041pap.pdf

Cullen Roche wrote:Banks are never reserve constrained.  They are always capital constrained.  Reserves are used for only two purposes – to settle payments in the overnight market and to meet the Fed’s reserve ratios.  Aside from this, reserves have very little impact on the day to day lending operations of banks in the USA.

Source: http://pragcap.com/the-myth-of-the-mone ... -follow-up

And the reserve ratio is currently "zero".

The Federal Reserve wrote:The dollar amount of a depository institution's reserve requirement is determined by applying the reserve ratios specified in the Federal Reserve Board's Regulation D to an institution's reservable liabilities (see table of reserve requirements). Reservable liabilities consist of net transaction accounts, nonpersonal time deposits, and eurocurrency liabilities. Since December 27, 1990, nonpersonal time deposits and eurocurrency liabilities have had a reserve ratio of zero.

Source: http://www.federalreserve.gov/monetaryp ... rvereq.htm

So, the textbooks that all taught us "fractional reserve banking" in elementary school are all obsolete now.

Except for the last paragraph on that linked page. Where does the interest come from?

"This interest money can either be real money or more credit money. If there wasn't enough real money created to cover this interest money then another loan has to be taken out to create the credit money to pay the interest. This starts a cycle of having to constantly create more credit money to pay the interest"

Mdraf wrote: Except for the last paragraph on that linked page. Where does the interest come from?

"This interest money can either be real money or more credit money. If there wasn't enough real money created to cover this interest money then another loan has to be taken out to create the credit money to pay the interest. This starts a cycle of having to constantly create more credit money to pay the interest"

Correct. That's what I've been saying!!

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

[align=center][/align]


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

[align=center][/align]

That's what it means to have a debt-based and credit-based monetary system. The entire currency (except coins) is all debt. And, partially thanks to the compounding interest payments, debt and credit all keep growing and growing, but that doesn't mean we have massive inflation!

If anything, we see that private credit has stalled tremendously in recent years. The increase in the National Debt is barely able to fill the hole in private credit (remember, the charts are different scales and private credit dwarfs the National Debt).

(btw, technically it's possible to pay off loans and interest without new money creation, but it requires the creditors constantly buying goods from the local economy, and that doesn't happen nearly enough).

And I should clarify... I'm not a fan of a debt-based society. It makes the system incredibly fragile as time goes on. The problem isn't really solvency (since it's all debt-based fiat). The problem — besides the inflation constraint — is fragility. The bigger private credit gets, the more unstable it becomes.

We are close to agreement but not quite. There is nothing wrong with debt because without debt there is no growth. HOWEVER, debt is only "Good" as long as it is conceivable that it "could theoretically be paid back". Hence my future taxation -> Productivity post. But you seem to imply that it doesn't matter, that debt can rise to infinity and it doesn't matter. (Please no links. Just use your own words).

PS I wrote the above before seeing your last post

Mdraf wrote: We are close to agreement but not quite. There is nothing wrong with debt because without debt there is no growth. HOWEVER, debt is only "Good" as long as it is conceivable that it "could theoretically be paid back". Hence my future taxation -> Productivity post. But you seem to imply that it doesn't matter, that debt can rise to infinity and it doesn't matter. (Please no links. Just use your own words).

PS I wrote the above before seeing your last post

Good, good. I agree that the debt must be paid back. But, my point is that the government has no problem paying its obligations even when the tax rate is zero.

Say the government owes somewhere between $250 billion and $450 billion in interest payments next year. The government doesn't need to raise that money from tax holders. It can just sell more T-Bonds.

But, how does the government sell those T-Bonds without taxation? As I've said before... Every time the government holds a bond auction, the bonds are purchased with previously spent government money that becomes reserves held in reserve accounts at the Fed. The reserves become bigger and bigger (i.e. excess reserves) as the government spends the money from the previous bond auction. So, the government holds a bond auction and those reserves are converted (or drained) into T-Bonds. Banks and consumers are happy because now they have government-backed interest bearing reserves (i.e. "savings") rather than cash.

The point is that there is always a demand for the T-Bonds so long as people are willing to save and new excess reserves are always being created from government spending.

Warren Mosler (an MTTer) has a line of red text in the upper right hand corner of his website. It reads...

[align=center]The funds to pay taxes and buy government securities come from government spending[/align]

Think about that for a second. As crazy as it sounds, what he is saying is true. But, how can government securities be backed by "Taxation" when the funds to pay those taxes come from debt issuance? Ah hah!

Mind you, Mosler absolutely recognizes the necessity for taxation — not to fund the bond issuance, but to provide the demand for the currency (i.e. pay your taxes with this currency, or you will go to jail.)

Oh dear, I think we are back to disagreement 
But I won't rehash the whole thing again.  Lets look at another angle.
According to your scenario "In the beginning...." Government issued debt. That debt eventually ends up on the balance sheet of the Fed after having made the private sector rich.  Then please explain why the Fed can't "tear up" the bonds and instantly wipe out a government debt?

Mdraf wrote: Oh dear, I think we are back to disagreement 

If you have a disagreement, why don't you clarify what it is? I don't believe I said anything factually incorrect, but please correct me if you think I did.

Mdraf wrote:But I won't rehash the whole thing again.  Lets look at another angle.
According to your scenario "In the beginning...." Government issued debt. That debt eventually ends up on the balance sheet of the Fed after having made the private sector rich.  Then please explain why the Fed can't "tear up" the bonds and instantly wipe out a government debt?

I don't understand the question. Why would the Fed want to tear up its bonds? If it did that, it wouldn't have any assets to trade back to the private sector for POMOs. And any debt owed to the Fed is just returned to the Treasury after the Fed pays its employees and electricity bills. The bonds themselves are assets!

The fact of the matter is that the Fed could not create dollars without the debt existing in the first place. So, it all comes back to debt. The debt is necessary for the money supply to exist (except coins, which are "debt free" money).

Not only are T-Bonds assets, T-Bonds are the private sector's savings!

We already know this because 50% of our Permanent Portfolios are T-Bonds! They are our assets.

The government's liabilities are the private sector's assets.

TennPaGa wrote:

Gumby wrote:
(btw, technically it's possible to pay off loans and interest without new money creation, but it requires the creditors constantly buying goods from the local economy, and that doesn't happen nearly enough).

Given that a loan creates the principal, but not the interest, I don't understand how all loans could be repaid without additional money coming into the system from somewhere outside the "system" (e.g. another country's economy).

Bob and George are flat broke and seek loans to fund their consumption activities. The First Third Fifth United Patriotic Bank of Pointedstick makes a loan to each of them of 100 pointed sticks at 5% interest and coming due in 10 years.

Each year, Bob the hunter/farmer/logger/miner purchases 5 pointed sticks worth of goods from George the blacksmith/tanner/construction worker/chef , and George does likewise from Bob. Each year, they pay 5 of their pointed sticks to the bank, and after 10 years, the bank has 100 pointed sticks, and each of them has 50. Neither of them can pay back the loan, so they default, and the bank goes bankrupt. Their society turns to barter and scrip.

Oops. That didn't turn out to be a very good example.

Here is how I can repay 110 "bucks" when only 100 bucks exist (and you start out holding all of them), without anyone else or any other money supply being involved:

Step 1: You lend me 100 bucks (now I have 100 bucks, you have 0 bucks, and with interest I owe 110 bucks)
Step 2: I buy some widgets from you for 45 bucks (now I have 55 bucks, you have 45 bucks, and I owe 110 bucks)
Step 3: I repay 55 bucks of my debt to you (now I have 0 bucks, you have 100 bucks, and I owe 55 bucks)
Step 4: I use the widgets to make some gizmos
Step 5: I sell the gizmos to you for 55 bucks (now I have 55 credit, you have 45 bucks, and I owe 55 bucks)
Step 6: I repay the remaining 55 bucks (now I have 0 bucks, you have 100 bucks, and I owe nothing)

Tada!!

But, that's a very simple micro example. And it only works if the economy remains healthy and the creditors are willing to spend money before all loans are due (as I did in the example above). In reality that rarely ever happens enough. So, more often than not, private credit snowballs and you need an ever-expanding money supply (created by issuing public debt or more private credit). Of course, some loans just go bad, so that happens too.

Gumby wrote: If you have a disagreement, why don't you clarify what it is? I don't believe I said anything factually incorrect, but please correct me if you think I did.

I shouldn't have opened the new tangent about tearing up bonds. We can get back to that later.

The disagreement relates to The Beginning. For the government to issue debt in a currency there has to be a value attached to that currency.  At first the dollar was issued and it was worth $xx.00 of gold. Then it was accepted and became a means of exchange. Only because people believe that they COULD get the gold if they wanted to. Once the currency is accepted as a means of exchange (eg. $100 = 100 hamburgers, or $100 = 10 goats) then government can go ahead and unlink it from the original value setter.

If a country declares independence and issues its own currency they will link its original value to another currency which people have faith in.  They cannot issue a new currency as say One New Token = 100 Zimbabwe dollars.

So my point goes back to the fact that there needs to be value, or a means to measure value.

Pointedstick wrote:

TennPaGa wrote:

Gumby wrote:
(btw, technically it's possible to pay off loans and interest without new money creation, but it requires the creditors constantly buying goods from the local economy, and that doesn't happen nearly enough).

Given that a loan creates the principal, but not the interest, I don't understand how all loans could be repaid without additional money coming into the system from somewhere outside the "system" (e.g. another country's economy).

Bob and George are flat broke and seek loans to fund their consumption activities. The First Third Fifth United Patriotic Bank of Pointedstick make a loan to each of them of 100 pointed sticks at 5% interest and coming due in 10 years.

Each year, Bob the hunter/farmer/logger/miner purchases 5 pointed sticks worth of goods from George the blacksmith/tanner/construction worker/chef , and George does likewise from Bob. Each year, they pay 5 of their pointed sticks to the bank, and after 10 years, the bank has 100 pointed sticks, and each of them has 50. Neither of them can pay back the loan, so they default, and the bank goes bankrupt. Their society turns to barter and scrip.

so pointedstick issues a bunch more loans to Bob or George depending on who he likes more, and to a couple other guys as well, some go bust some pay back the loan...  pointed stick keeps issuing loans, increasing the money supply, picking winners and loser's and gaining power.. everybody is happy ? ? ? ? 

Gumby wrote: And it only works if the economy remains healthy and the creditors are willing to spend money before all loans are due (as I did in the example above).

And crucially, it requires that borrowed money be used for productive purposes that result in goods or services that can be sold for more than the owed principal on the loan. The more people borrow money to purchase sports cars and couches and flat-screen TVs and trips to Disneyland, the more money to cover the interest has to be created.

l82start wrote: so pointed stick issues a bunch more loans to Bob or George depending on who he likes more, and to a couple other guys as well, some go bust some pay back the lone...  pointed stick keeps issuing loans, picking winners and loser's and gaining power.. everybody is happy ? ? ? ? 

Hey, turns out being a government is easy!  Can I sign anyone up for some pointed sticks?

Mdraf wrote: The disagreement relates to The Beginning. For the government to issue debt in a currency there has to be a value attached to that currency.  At first the dollar was issued and it was worth $xx.00 of gold. Then it was accepted and became a means of exchange. Only because people believe that they COULD get the gold if they wanted to. Once the currency is accepted as a means of exchange (eg. $100 = 100 hamburgers, or $100 = 10 goats) then government can go ahead and unlink it from the original value setter.

If a country declares independence and issues its own currency they will link its original value to another currency which people have faith in.  They cannot issue a new currency as say One New Token = 100 Zimbabwe dollars.

So my point goes back to the fact that there needs to be value, or a means to measure value.

That's an interesting point, but imagine that this happens instead:

A bunch of libertarians go and actually found Galt's Gulch, and while it has a government, it's a very small government. The government decides to set a yearly flat tax of 5% and create a new currency called the New Token. So it starts by sending everyone 10,000 New Tokens and demanding 5% back every year. Penalty for nonpayment is deportation.

In this case, isn't the value of that currency the fact that people want to live in Galt's Gulch?

Pointedstick wrote:

Mdraf wrote: The disagreement relates to The Beginning. For the government to issue debt in a currency there has to be a value attached to that currency.  At first the dollar was issued and it was worth $xx.00 of gold. Then it was accepted and became a means of exchange. Only because people believe that they COULD get the gold if they wanted to. Once the currency is accepted as a means of exchange (eg. $100 = 100 hamburgers, or $100 = 10 goats) then government can go ahead and unlink it from the original value setter.

If a country declares independence and issues its own currency they will link its original value to another currency which people have faith in.  They cannot issue a new currency as say One New Token = 100 Zimbabwe dollars.

So my point goes back to the fact that there needs to be value, or a means to measure value.

That's an interesting point, but imagine that this happens instead:

A bunch of libertarians go and actually found Galt's Gulch, and while it has a government, it's a very small government. The government decides to set a yearly flat tax of 5% and create a new currency called the New Token. So it starts by sending everyone 10,000 New Tokens and demanding 5% back every year. Penalty for nonpayment is deportation.

In this case, isn't the value of that currency the fact that people want to live in Galt's Gulch?

No. The value in this case will be set by the inhabitants. I'll give you 1 New Token for your Toyota. Are you nuts? I want 15 New Tokens. Etc

Addendum: but this is not reality. I can't think of an example where government simply gives out currency.

Mdraf wrote: No. The value in this case will be set by the inhabitants. I'll give you 1 New Token for your Toyota. Are you nuts? I want 15 New Tokens. Etc

Addendum: but this is not reality. I can't think of an example where government simply gives out currency.

Right. The actual exchange rate and precise value is determined by the private sector. But the fact that I don't think it's nuts that you're even offering me these worthless pieces of paper marked "New Tokens" for my extremely valuable Toyota is what the government accomplishes. It ensures that we all want to have some amount of these dumb pieces of paper saying, "New Token" on them by threatening us somehow if we don't have enough.

Mdraf wrote:

Gumby wrote: If you have a disagreement, why don't you clarify what it is? I don't believe I said anything factually incorrect, but please correct me if you think I did.

I shouldn't have opened the new tangent about tearing up bonds. We can get back to that later.

The disagreement relates to The Beginning. For the government to issue debt in a currency there has to be a value attached to that currency.  At first the dollar was issued and it was worth $xx.00 of gold. Then it was accepted and became a means of exchange. Only because people believe that they COULD get the gold if they wanted to. Once the currency is accepted as a means of exchange (eg. $100 = 100 hamburgers, or $100 = 10 goats) then government can go ahead and unlink it from the original value setter.

If a country declares independence and issues its own currency they will link its original value to another currency which people have faith in.  They cannot issue a new currency as say One New Token = 100 Zimbabwe dollars.

So my point goes back to the fact that there needs to be value, or a means to measure value.

But you don't need the value... remember my example of the fiat dollars and the "tax" that needs to be paid in those worthless pieces of paper is going to make them valuable.

I believe this was done with English currency in Africa when they were colonizing it, and the Africans had no concept of currency.