Back in the olden days, in the long long ago, before about 1913, we didn't have a monopolistic cartel of private banks headed by a few unelected officials who were in charge of the nation's (and, more recently, the world's) money supply. But, other than money supply, another great power of the Federal Reserve is to dictate interest rates, either directly or indirectly. It's this power that gives us nearly every economic boom (Read: Bubble) because the central bank loves to keep interest rates too low for too long, thereby creating excess credit that eventually funnels into a single area and creates a bubble. But what would the world be like if Bernanke couldn't control interest rates? Well, this thing called the "free market" could take care of that. And it's actually pretty simple.
In a truly free market the interest rate would be determined by the amount of savings. When someone deposits money into a savings account, what they're essentially saying is that they are going to under-consume today so that they can consume more in the future. If enough people do this, and the amount of deposits on the bank's book increases, banks will lower interest rates. This lowering of interest rates does two things. First, it makes it cheaper for businesses to borrow money, thereby encouraging it. After all, interest is simply the cost of money. Lower interest rates can make a huge difference to a business that plans on investing a lot of money that won't start to turn profits for many years. Think of R&D departments that attempt to invent new technologies that won't be sold in a store for 10 or 20 years. The difference between 5% and 4% could be millions and millions of dollars. So as savings are build up, interest rates go down and long term investments become feasible. This works out wonderfully because the money that is being used to finance these long term investments that don't pay off until some future date is the very savings that people put away in order to be able to consume something in the future. This consistency in the time factor cannot be stressed enough. Not until people decide to consume in the future (save) can business start to invest in their future (borrow).
The second thing lower interest rates do is discourage savings. If you're only gaining 2% on a savings account you're going to save a lot less than when you were getting, say, 5%. This allows the banks to lend out their deposits, which is how they make most of their money. Once most of the deposits are lent out, the banks will need to start raising interest rates. This will encourage more savings and allow banks to rebuild their deposits at the same time that it discourages borrowing. Again, the time factor works out perfectly here. As people are consuming more today, it becomes harder for a business to invest in the future. This cycle continues with the competition between banks, saving habits of the individual and borrowing needs of business all working together to determine the interest rate.
But like I said, that system died a long time ago. How wonderful that we progressed enough to cast away those quaint relics of yesteryear. That awful era where unintelligent rubes didn't have the know-how to properly manage a nation's economy, money and credit. At least now we realize that we simply need the right people in charge. And as long as we just allow those brilliant economic planners to turn the dials the perfect amount and press the right buttons in the proper sequence we'll be alright. They'll give us the perfect amount of credit and just the right level of money supply. The waste and inefficiency of saving can be eliminated without effecting the ability of business to borrow and invest. I don't see how this could possibly go wrong...
Monday, May 9, 2011
Sunday, April 10, 2011
Debt Ceiling, Default And Teleporters
With all the budget talks lately, the fact that we are quickly approaching the debt ceiling is slipping under the radar. But we'll hit our debt target in about a month, maybe 6 weeks, and then congress will be forced to raise that limit. That the debt limit will get raised is a guarantee, the only question is how much it will get raised.
The pundits on TV will tell you that we need to raise the debt ceiling because failing to do so will destroy our bond market, raise interest rates and ultimately cause us to default on our debt. The problem is that all of those things are going to happen anyway. Guaranteed. Sure, there are things that government can do (and they have been doing these things for years) to put off this inevitability into the future. But the longer we delay these problems, the worse they will become.
Anybody who thinks we won't default on our debt is either a lunatic, drunk or both. So if we will not pay back our debt, we must default on it. There are two ways that governments can do this. First, they can be honest about the situation and restructure the debt. They can get their budget in order and then make deals with their lenders where they don't get paid 100% of their loans but at least they get paid in money that has some value. The problem is that the budget need to be balanced for this to work. We almost saw a government shutdown because politicians couldn't agree on whether to cut $30 billion or $60 billion. OUT OF A $1.6 TRILLION YEARLY DEFICIT! On my most optimistic day I can imagine a scenario where we try really hard and our politicians are willing to fight for a balanced budget and we'll maybe see one in 15 or 20 years. Even if that would happen, it's not nearly soon enough. I don't think we have 5 years before the system breaks down. So option 1 is out the window.
The second way to default on the debt is to inflate it away. That is, we simply print new money to pay our debts. Our lenders will get their money, but they will be paid in money that is worth much less than the money they lent us. This is the worst option, but it's becoming clear that it is the option we'll take. As long as the debt ceiling continues to be raised, as long as interest rates stay extremely low, as long as the Fed is willing to print money to monetize our debt, and as long as someone is willing to lend us money at the low interest rates this is what we will do.
But that option can only work so long as all of those things stay true. Once one of those factors goes away, the bubble will pop, interest rates will skyrocket, the dollar will plummet, we will default on our debt and hyperinflation becomes a real threat. Notice that the end result of that scenario is nearly identical to the end result of not raising the debt ceiling right now. Like I said, all of those things are going to happen sooner or later. The only option we have is whether we want to face the problems today, take the medicine and deal with the pain (and trust me, it will be very painful), or keep delaying the problem until it's impossible to do so any longer and in the meantime pray for some new technology or invention (like a teleporter for example) that completely changes the nature of our economy. Barring a new, revolutionary technology, the end result of this option is only a deeper and more painful recession/depression than what we would have to face right now.
The pundits on TV will tell you that we need to raise the debt ceiling because failing to do so will destroy our bond market, raise interest rates and ultimately cause us to default on our debt. The problem is that all of those things are going to happen anyway. Guaranteed. Sure, there are things that government can do (and they have been doing these things for years) to put off this inevitability into the future. But the longer we delay these problems, the worse they will become.
Anybody who thinks we won't default on our debt is either a lunatic, drunk or both. So if we will not pay back our debt, we must default on it. There are two ways that governments can do this. First, they can be honest about the situation and restructure the debt. They can get their budget in order and then make deals with their lenders where they don't get paid 100% of their loans but at least they get paid in money that has some value. The problem is that the budget need to be balanced for this to work. We almost saw a government shutdown because politicians couldn't agree on whether to cut $30 billion or $60 billion. OUT OF A $1.6 TRILLION YEARLY DEFICIT! On my most optimistic day I can imagine a scenario where we try really hard and our politicians are willing to fight for a balanced budget and we'll maybe see one in 15 or 20 years. Even if that would happen, it's not nearly soon enough. I don't think we have 5 years before the system breaks down. So option 1 is out the window.
The second way to default on the debt is to inflate it away. That is, we simply print new money to pay our debts. Our lenders will get their money, but they will be paid in money that is worth much less than the money they lent us. This is the worst option, but it's becoming clear that it is the option we'll take. As long as the debt ceiling continues to be raised, as long as interest rates stay extremely low, as long as the Fed is willing to print money to monetize our debt, and as long as someone is willing to lend us money at the low interest rates this is what we will do.
But that option can only work so long as all of those things stay true. Once one of those factors goes away, the bubble will pop, interest rates will skyrocket, the dollar will plummet, we will default on our debt and hyperinflation becomes a real threat. Notice that the end result of that scenario is nearly identical to the end result of not raising the debt ceiling right now. Like I said, all of those things are going to happen sooner or later. The only option we have is whether we want to face the problems today, take the medicine and deal with the pain (and trust me, it will be very painful), or keep delaying the problem until it's impossible to do so any longer and in the meantime pray for some new technology or invention (like a teleporter for example) that completely changes the nature of our economy. Barring a new, revolutionary technology, the end result of this option is only a deeper and more painful recession/depression than what we would have to face right now.
Saturday, March 12, 2011
American Foreign Policy: The Flow Chart
I know it's difficult at times to wrap your head around the foreign policy decisions that American leadership makes, so I've devised this handy flow chart to help makes some sense of it. Hopefully this helps to clear up some of the misunderstandings. (Click the image to make it larger)
Monday, March 7, 2011
Quantitative Easing: To Infinity And Beyond
Since the Great Recession started a couple years ago*, the federal reserve has been involved in a process called "Quantitative Easing". I've discussed this before so I won't go into the process any further. The second round of Quantitative Easing, QE2, is set to expire at the end of June. Watch the talking heads on TV and they'll tell you, almost unanimously, that there will be no further rounds of QE. Their reasoning is that the economy is turning around. I think the economy only appears to be turning around because of the QE, and the recovery isn't sustainable without it. Either my laymen understanding of our economic condition is terribly wrong, or these guys are grossly stupid. I have a very healthy ego so I'm going to go with the latter. Here's why I think that QE3, QE4, QE5, etc will happen.
As I mentioned in the article I linked above, the federal government is running huge deficits, and will be doing so for at least the next decade. This means that the treasury has to sell bonds to cover the budget deficits. Since QE2, the federal reserve has been buying 70% of new treasury bonds. When QE2 ends, and the fed stops buying treasuries, someone has to pick up the slack. And that's a lot of slack.
You might be thinking that China will come to the rescue again, but I don't think they can continue to do that. When they buy our treasuries, they have to print money to do so, which causes inflation. They're already experiencing a high level of inflation, possibly as much as 10% or more. They're currently importing much of our inflation in order to keep their currency pegged to our dollar. But the inflation problem in China (and all over the world really) is leading to some civil unrest that The State needs to avoid. As we've recently seen in the Middle East, citizens will put up with brutal regimes as long as they have a job and can afford food. By printing money, we're pushing up the price of food all over the world, China included.** In order to get their inflation under control and calm the citizenry, China is going to have to stop buying our debt with money they print.
So if not China, then who? That's a very good question. A better question might be How much interest are these unknown buyers going to charge? Since the fed represents 70% of bond demand, once they quit buying bonds the demand will drop and interest rates will surge. If interest rates go up significantly, the federal government is going to have to find more buyers of our debt to cover the higher amount in interest payments plus the new debt we take on. Finding more buyers of this debt in a market where demand is low will push interest rates up higher, which will cause us to have to find even more buyers who will demand higher interest which will cause us to find even more buyers which will... well, you get the idea. It's called a Ponzi Scheme, and even Bernie Madoff recognizes that our entire government operates as one. If there are no buyers of our debt other than the federal reserve, the federal reserve will be forced into filling that gap in order to keep interest rates low.
Another problem is that the economy cannot sustain the "growth" we've experience over the past 6 months or so without the money that the fed is providing through QE2. On average, the federal reserve has been purchasing 5-8 billion dollars of treasuries a day and injecting that new money into the system. This has been great news for stocks since the vast majority of that money makes its way to the big guys on Wall Street. Ever since "Jackson Hole" late last August, when the fed announced their plan for QE2, stocks have almost gone straight up***. Before that, the economy was in shambles in the vacuum left behind after QE1. Things aren't much different now than they were last summer. Many of our problems have not been fixed and most of the ones that matter are even worse today. Once the fed stops pumping money into the economy, the "recovery" will sputter and there will be a lot of pressure on them to fire up the printing press.
There is a problem though. The public is becoming more and more nervous about all of the money printing. Luckily for Washington, the public is also easily manipulated.If QE3 happ When QE3 happens, they can do it without calling it that officially. QE2 is written in such a way that it can be expanded upon if the fed chooses to do so. That means that we do another round of Quantitative Easing but call it a continuation of QE2, or some other goofy name altogether. It will also be interesting to see what tragedy or crisis they say we are on the brink of in order to convince the public that it is necessary. I'm of the mindset that we're already on the brink of an economic depression if we stop the QE(insert number). But as I've said before, that is an inevitability that is only being delayed and intensified by the actions of the federal reserve. If we continue on this QE/huge deficit spending path, we're almost guaranteeing that we experience hyperinflation and a total economic collapse. The sooner we try to deal with the mess in a real and honest way, the better. 2008 would have been a nice time to start...
*Fun fact: The Great Recession officially ended in September 2010. That's according to Government Data though. Mark Twain popularized the phrase "There are lies, damned lies, and statistics." Today that phrase would be "There are lies, damned lies, statistics, and government statistics."
**Because we have the world's reserve currency, food is traded in US dollars in the world markets. When we print 2 trillion dollars to prop up our economy, we also bring the price of food up across the world. These Mid-East protests can be directly linked to our inflationary monetary policy. If it spreads to Saudi Arabia, I hope you can afford $5(probably even more) gas
*** This chart shows the DOW from a couple weeks before the announcement of QE2 (end of August) until now. Stocks were falling until the minute QE2 was announced. Wall Street loves free money from the fed.
As I mentioned in the article I linked above, the federal government is running huge deficits, and will be doing so for at least the next decade. This means that the treasury has to sell bonds to cover the budget deficits. Since QE2, the federal reserve has been buying 70% of new treasury bonds. When QE2 ends, and the fed stops buying treasuries, someone has to pick up the slack. And that's a lot of slack.
You might be thinking that China will come to the rescue again, but I don't think they can continue to do that. When they buy our treasuries, they have to print money to do so, which causes inflation. They're already experiencing a high level of inflation, possibly as much as 10% or more. They're currently importing much of our inflation in order to keep their currency pegged to our dollar. But the inflation problem in China (and all over the world really) is leading to some civil unrest that The State needs to avoid. As we've recently seen in the Middle East, citizens will put up with brutal regimes as long as they have a job and can afford food. By printing money, we're pushing up the price of food all over the world, China included.** In order to get their inflation under control and calm the citizenry, China is going to have to stop buying our debt with money they print.
So if not China, then who? That's a very good question. A better question might be How much interest are these unknown buyers going to charge? Since the fed represents 70% of bond demand, once they quit buying bonds the demand will drop and interest rates will surge. If interest rates go up significantly, the federal government is going to have to find more buyers of our debt to cover the higher amount in interest payments plus the new debt we take on. Finding more buyers of this debt in a market where demand is low will push interest rates up higher, which will cause us to have to find even more buyers who will demand higher interest which will cause us to find even more buyers which will... well, you get the idea. It's called a Ponzi Scheme, and even Bernie Madoff recognizes that our entire government operates as one. If there are no buyers of our debt other than the federal reserve, the federal reserve will be forced into filling that gap in order to keep interest rates low.
Another problem is that the economy cannot sustain the "growth" we've experience over the past 6 months or so without the money that the fed is providing through QE2. On average, the federal reserve has been purchasing 5-8 billion dollars of treasuries a day and injecting that new money into the system. This has been great news for stocks since the vast majority of that money makes its way to the big guys on Wall Street. Ever since "Jackson Hole" late last August, when the fed announced their plan for QE2, stocks have almost gone straight up***. Before that, the economy was in shambles in the vacuum left behind after QE1. Things aren't much different now than they were last summer. Many of our problems have not been fixed and most of the ones that matter are even worse today. Once the fed stops pumping money into the economy, the "recovery" will sputter and there will be a lot of pressure on them to fire up the printing press.
There is a problem though. The public is becoming more and more nervous about all of the money printing. Luckily for Washington, the public is also easily manipulated.
*Fun fact: The Great Recession officially ended in September 2010. That's according to Government Data though. Mark Twain popularized the phrase "There are lies, damned lies, and statistics." Today that phrase would be "There are lies, damned lies, statistics, and government statistics."
**Because we have the world's reserve currency, food is traded in US dollars in the world markets. When we print 2 trillion dollars to prop up our economy, we also bring the price of food up across the world. These Mid-East protests can be directly linked to our inflationary monetary policy. If it spreads to Saudi Arabia, I hope you can afford $5(probably even more) gas
*** This chart shows the DOW from a couple weeks before the announcement of QE2 (end of August) until now. Stocks were falling until the minute QE2 was announced. Wall Street loves free money from the fed.
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