Inflation/ Deflation
This is my response to question I posted on the Housing Bubble 2 Blog
Inflation/ Deflation
What do I mean when I say “if you cannot get your money out of the banking system en-mass hyper inflation is a very real risk.”
You are correct in assuming that when debt is defaulted upon, forgiven, or repudiated, then there is deflation. However, many countries go through asset bubbles and experience inflation, or hyper inflation when the debt stops expanding and implodes.
So then what is the difference?
Why deflation is for some and inflation for others?
The first mistake is thinking that prices in the Depression declines to their pre-asset bubble levels. They did not. Not even close. The economy in the depression experienced a very slight deflation.
The money supply only shrank from $68.25 billion to $64.72 billion for a decline of only $3.2 billion. The total money supply from the middle of 1929 at the height of the bubble started at $73.3 billion and only fell to $64.7 billion in 1932. This is a total compression of the money supply of only 11.6% or 3.3% per year. The inflation rate of the money supply was 7.7% per year during the boom in the 1920’s. Therefore we hardly deflated at all and prices never went down to their pre asset bubble prices.
So why didn’t we get a higher rate of deflation due to all of these bankruptcies, debt forgiveness, and repudiation of debt, because we were still inflating the currency. The inflation was just not enough to counter the downward forces of oversupply, increased efficiency, and destruction of money, and pulling money out of the banking system.
What does “removing money from the banking system en-mass” mean?
This means that the population and foreign countries as a whole can remove their money out of our banking system. American’s have the lowest rate of savings in the world, so what are you going to take out of the banking system, credit card debt? What currency would you then use to purchase things, you still must use the dollar, you cannot use gold or foreign currency inside of the country, it is against the law.
American’s are encased in a financial web of the banking system and don’t even truly understand it. Social Security, Medicare, Pensions, 401(k), 403(b), any retirement plan, and investment, and any purchase ends up in the bank. You can’t even operate a major corporation, or even a small corporation without being heavily tied to the banking system to pay bills with. Therefore American cannot get out of the banking system en-mass, and there is no other currency they can convert to, like gold. This blocks the deflationary aspect of the depression.
Common guys, its not like the Federal Reserve hasn’t thought think through isn’t it. You should just read some of their research papers on the subject. You would be shocked.
Foreign countries are so tied to us economically that they cannot get unwind their positions within our own financial systems without facing a banking crisis just based on that tactic. Less developed countries could very well become politically unstable. Therefore foreign governments cannot run to another currency at this time. Not that this may not change, just not right now.
Why does mass loan defaults tend to cause hyper inflation rather than deflation on an absolute monetary magnitude perspective. This means you are just looking at prices and ignoring buying power.
The defaults cause deflation, however, the act of the government buying up the defaulting mortgages leads to increasing the currency in order to pay for it, this then leads to increasing the base money in the banking system which can then be used to create additional credit. This leads to inflation or hyper inflation and not deflation. Defaults cause deflation, government policy causes inflation.
The next argument of protecting the dollar, the government will not bail out housing, leading to inflation or hyper inflation. This has never happened in the US since the Federal Reserve was formed in 1913. If people cannot service their mortgages, they the government must step in or the banks become insolvent, and without government intervention bankrupt. We are not talking about a few banks here, I am talking about the largest banks in the world, which by the way many of which are US banks will become insolvent. US will never give Economic Dominance without a war forcing it.
Japan had deflation when their asset bubble burst. Why?
Japan allowed their banks to hold onto their non-performing loans, loans which are not, and may never be serviced. Japan also borrowed heavily. It is more accurate to say Japan, even to this day has never recovered and they may very well face another major banking crisis again very soon.
Chromatic Dispersion
Banking, Derivatives, and Systemic Risk
http://bankdersysrisk.blogspot.com/
http://bankdersysrisk.blogspot.com/atom.xml
Inflation/ Deflation
What do I mean when I say “if you cannot get your money out of the banking system en-mass hyper inflation is a very real risk.”
You are correct in assuming that when debt is defaulted upon, forgiven, or repudiated, then there is deflation. However, many countries go through asset bubbles and experience inflation, or hyper inflation when the debt stops expanding and implodes.
So then what is the difference?
Why deflation is for some and inflation for others?
The first mistake is thinking that prices in the Depression declines to their pre-asset bubble levels. They did not. Not even close. The economy in the depression experienced a very slight deflation.
The money supply only shrank from $68.25 billion to $64.72 billion for a decline of only $3.2 billion. The total money supply from the middle of 1929 at the height of the bubble started at $73.3 billion and only fell to $64.7 billion in 1932. This is a total compression of the money supply of only 11.6% or 3.3% per year. The inflation rate of the money supply was 7.7% per year during the boom in the 1920’s. Therefore we hardly deflated at all and prices never went down to their pre asset bubble prices.
So why didn’t we get a higher rate of deflation due to all of these bankruptcies, debt forgiveness, and repudiation of debt, because we were still inflating the currency. The inflation was just not enough to counter the downward forces of oversupply, increased efficiency, and destruction of money, and pulling money out of the banking system.
What does “removing money from the banking system en-mass” mean?
This means that the population and foreign countries as a whole can remove their money out of our banking system. American’s have the lowest rate of savings in the world, so what are you going to take out of the banking system, credit card debt? What currency would you then use to purchase things, you still must use the dollar, you cannot use gold or foreign currency inside of the country, it is against the law.
American’s are encased in a financial web of the banking system and don’t even truly understand it. Social Security, Medicare, Pensions, 401(k), 403(b), any retirement plan, and investment, and any purchase ends up in the bank. You can’t even operate a major corporation, or even a small corporation without being heavily tied to the banking system to pay bills with. Therefore American cannot get out of the banking system en-mass, and there is no other currency they can convert to, like gold. This blocks the deflationary aspect of the depression.
Common guys, its not like the Federal Reserve hasn’t thought think through isn’t it. You should just read some of their research papers on the subject. You would be shocked.
Foreign countries are so tied to us economically that they cannot get unwind their positions within our own financial systems without facing a banking crisis just based on that tactic. Less developed countries could very well become politically unstable. Therefore foreign governments cannot run to another currency at this time. Not that this may not change, just not right now.
Why does mass loan defaults tend to cause hyper inflation rather than deflation on an absolute monetary magnitude perspective. This means you are just looking at prices and ignoring buying power.
The defaults cause deflation, however, the act of the government buying up the defaulting mortgages leads to increasing the currency in order to pay for it, this then leads to increasing the base money in the banking system which can then be used to create additional credit. This leads to inflation or hyper inflation and not deflation. Defaults cause deflation, government policy causes inflation.
The next argument of protecting the dollar, the government will not bail out housing, leading to inflation or hyper inflation. This has never happened in the US since the Federal Reserve was formed in 1913. If people cannot service their mortgages, they the government must step in or the banks become insolvent, and without government intervention bankrupt. We are not talking about a few banks here, I am talking about the largest banks in the world, which by the way many of which are US banks will become insolvent. US will never give Economic Dominance without a war forcing it.
Japan had deflation when their asset bubble burst. Why?
Japan allowed their banks to hold onto their non-performing loans, loans which are not, and may never be serviced. Japan also borrowed heavily. It is more accurate to say Japan, even to this day has never recovered and they may very well face another major banking crisis again very soon.
Chromatic Dispersion
Banking, Derivatives, and Systemic Risk
http://bankdersysrisk.blogspot.com/
http://bankdersysrisk.blogspot.com/atom.xml
posted by Chromatic Dispersion at 10/02/2005 08:03:00 PM
21 Comments:
this is all very interesting.
Chromatic, while you make a compelling case above, I feel that due to the sheer magnitude of the credit and derivatives markets, large-scale defaults (which, IMHO, are highly likely when real estate collapses and our asset-based economy tanks along with it) will overwhelm the government's ability to print us out of a deflation. It's not like our government isn't in enough deficit trouble already. China and Japan, who have been dependent upon our spending binge over the past several years, will no longer have the continuing flood of dollars with which to help bail us out. Your thoughts?
Chromatic, while you make a compelling case above, I feel that due to the sheer magnitude of the credit and derivatives markets, large-scale defaults (which, IMHO, are highly likely when real estate collapses and our asset-based economy tanks along with it) will overwhelm the government's ability to print us out of a deflation. It's not like our government isn't in enough deficit trouble already. China and Japan, who have been dependent upon our spending binge over the past several years, will no longer have the continuing flood of dollars with which to help bail us out. Your thoughts?
Thanks for your post,
Lets first take on you first statement about deflation and how it arises. This would indicate that the money supply is declining inducing reduction in asset prices (housing). The US dollar is overvalued is as a result jobs are shifting to cheaper, but not less incapable countries. So it looks like deflation is not only possible, but the pressures all look for a decline in labor costs and prices due to international economic pressure.
However, the US dollar is the world’s reserve currency. This means that all currencies are compared to the US dollar before any two currencies are exchanged with each other. Also foreign central banks, the countries banks have a majority of their assets in terms of the US dollar. This situation is similar to the post World War One when most of the world was on the British pound standard.
During WW1 England and all of the other European countries left their gold standards in order to fund the war. They therefore expanded their respective money supplies greatly. After the war England, whom was one of the financial leaders of the time, decided that they would restore England to economic leadership if they returned to the British pound sterling relationship to gold at the pre-WW1 level.
The banking system had already been moving away from gold as a world currency and replacing government debt (this is really the ability to obtain tax money) as the banks core reserve (the banks basis for lending out credit). Because government bonds, sovereign debt, is now used as a basis for a bank reserve, this linked money created through fractional reserve banking to a countries debt load.
This lead to a situation whereas countries now had a gold standard in writing, but in actuality there was no possibility of redemption in gold on a mass scale due to currency created through over lending. The ratio of gold as the core holding of banks was being diluted by the future of future tax revenues (i.e. government debt). Currencies of the world were basically severely overleveraged in relationship to gold even before WW1.
Therefore a system of agreements was in place between trading countries so that promises were made for payment is gold, but gold didn’t actually leave their country en-mass before WW1. This is not to say that gold didn’t leave the countries, only that the rate at which it left was very negotiable.
Why a gold standard? Countries wanted to tie their currencies to gold because tying it to future tax revenue has always been unstable and lead to unlimited creation of money through printing, leading of course to the devaluation of buying power of the currency. With the illusion of gold backing the currency, the countries of the world could claim their currency was stable as long as they could redeem the paper currency for gold coins to the population. They then enacted policies to drive hard currency out of circulation until the final outcome was that gold was really only used for international settlements.
So in order to redeem their place as the center of the financial world, England came up with a plan that called for the British pound to return to its pre-WW1 value with gold. They then made payments to other European countries with British pound sterling. Foreign banks could then redeem their British pound sterling for gold inducing a control mechanism to slow gold from leaving England and making the British pound sterling the world’s reserve currency, much like the US dollar today.
As the value of the British pound sterling was still overvalued to the comparable money supply of other countries in its relationship to gold, this forced a negative trade balance with the other countries of the world. English currency entered the other countries like locus in a biblical curse.
During the 1920’s England refused to deal with their negative trade balance and provided money for their welfare state as unemployment skyrocketed. English sovereign debt and money supply went into to steep rise. Overextended as the English were, they continued to inflate their currency, but still kept their currency overvalued per agreements they had made with other central banks. This situation finally collapsed upon itself when England went off of the gold standard right before they had exhausted their supply of gold. This caused massive inflation in England.
So, as history dictates, countries will gladly sacrifice the value of their currencies buying power in order to pay for the social programs and government expenditures. Even though the banks are very very powerful, they cannot compete with the voting populist. This is because politicians are elected and not by banks, but by people. And politicians generally get elected by promising the what ever it takes to win an election.
As to our current situation with housing in the US, and the world for that matter you can expect some initial deflation in terms of the asset prices, but then the banking system will become unstable as banks become insolvent. If the banks cannot clear money transactions then the economic system get paralyzed as this induces first general insolvency and quickly, very quickly leads to bankruptcy.
With enough bankruptcies, which make it harder to people to earn an honest living, social breakdown always occurs. To combat this and keep in power the government must bail out the banking system. In bailing out the banking system will certainly deflate the buying power of the dollar. However the corollary to this is that prices rise very quickly.
Since the US dollar is the world’s reserve currency, exchange rates may not change that much between countries because this would induce similar situations all over the world.
Therefore Deflation, if you define it as the buying power of the dollar increasing can only happen as a lasting outcome with the total destruction of the banking system. The US would never allow this situation to happen, due to the fact that politicians are always trying to get re-elected and they need the political system in tact to do it, but the buying power of the dollar is an acceptable causality.
As for your comment
“I feel that due to the sheer magnitude of the credit and derivatives markets, large-scale defaults (which, IMHO, are highly likely when real estate collapses and our asset-based economy tanks along with it) will overwhelm the government's ability to print us out of a deflation”
There is no limit to how much the US can print. All that happens is that the world hyper-inflates with us, stealing the paper saving private citizens all over the world have accumulated. This would not be the first time a world currency has failed. The country in question just inflates in order to prevent social disintegration.
As I stated before the only way with paper money you can have deflation is if you can
A. A mass exodus from the banking system, this is really not possible any more
B. A competing currency is available, all other currencies are based upon the US dollar and gold is no longer a currency that can be used.
C. Loss off Faith in the banking system, possible, but you have to at least have A or B in order to derail the amount of money created through fractional reserve banking and fend off inflation by removing money from the banking system.
D. Hyperinflation can happen regardless of anything else. The government just prints its way out of debt. This happens every few years somewhere on the globe. There is NO DEBT LEVEL TOO HIGH THAT A COUNTRY WITH DEBT DEFINED IN TERMS OF ITS OWN CURRENCY CANNOT HYPER INFLATE OUT OF. Hyper inflation causes problems, but not nearly as many as the collapse of the banking system, at least from a political point of view.
China and Japan?
These countries economic systems are at risk just like any other country that holds large amounts of our debt compared to their economy. All countries will be affected, and their currencies shall fail, meaning their political system is destroyed as well, or they will hyper inflate, with almost as many political dire consequences.
Chromatic Dispersion
Chromatic,
Excellent post, but very depressing. Thanks for clarifying.
I am just trying to grasp the ideas behind the deflation vs inflation debate. I get your point that the money destruction through defaults leads to deflation, but I don't agree that the fed injection of liquidity into the insolvent banking system would produce inflation. Following the implosion, I think the banks will revise their easy lending standards to make credit less obtainable...in addition, I think the bankruptcy law will take many consumers out of the economy as they are trapped into Ch 13, thereby unable to spend as freely as in times past.
Also, we are forgetting the piss poor savings rate in the US and the HUGE increase in debtr loads carried by these people. For those not pushed into BK, the rest will be paying off their prior purchases forever....
SO with the US consumer out of the loop, and production capability so high in China, I see prices falling relative to the dollar in this scenario.
Anon,
I agree that their will be deflation, the first thing one has to realize is that deflation can occur in many different forms.
A.) Prices remain the same, but you receive additional product or services.
B.) Income increases, but prices of goods remain the same or do not increase at the same rate.
C.) Income falls, however, prices of goods fall even faster.
Therefore let’s look at the problem again. You are correct that there is world wide deflationary pressure in the world wages. This means that prices of goods can fall due to declining cost of production.
However, when a country creates money either through creating new money (just printing money), or hyper-lending, this leads to a situation whereas too much money is chasing too little items, increasing cost. Does this mean that prices rise, not necessarily, it does however mean that prices do not fall as far as they should if the currency supply was not increased, causing inflationary pressures to offset deflationary pressures.
This leads to a very interesting phenomenon, why is the US money supply increasing exponentially while goods and services within the country are relatively stable? Are not home owners taking out loans against their homes and buying all kinds of goods with them? Doesn’t this increase the money supply in the general economy through the purchase of TVs, SUV’s, Computers, I-pods, and other such goods?
Prices stay stable for two main reasons, most of our goods are made oversees, therefore when you purchase these goods you add to the negative trade balance, which means your money is leaving the country. The money which the stores make as profit is added to the currency pool, increasing the money supply. However this and the Federal Reserve creating new money to add to the money supply is offsetting deflation from oversees, stabilizing prices.
Therefore the prices of goods in this country should be cheaper through deflation, but through inflation of the money supply prices are held up. So you end up paying more than your should, even though prices have not risen.
Why does bailing out the banking system lead to inflation rather than deflation. I understand this can be a hard concept but my recent article on The Great Depression went into this subject in depth.
It is true that commercial banks tighten up lending during a banking crisis because they are maxed out of bad loans. This leads to the banks becoming defensive and raising lending standards, to sometimes insane heights. Not only is this well documented, but very true. The money supply would stop increasing through the extension of credit and start decreasing. This would cause all kinds of additional deflationary pressures.
However, the banks get bailed out by the government. This means that the government purchases the bad loans from these banks. Where does the government get the money to do obtain these loans? It borrows the money, uses tax money, or creates money through the Federal Reserve. This is basically just devaluing the purchasing power of all of the currency when the Federal Reserve creates new money.
When the government buys these loans off of the banks the banks now get the entire loan amount paid off, by the government with depreciating currency. They can now create even more money through lending. This situation is also well documented.
Therefore a period of tight credit when the banking system is in distress, after the government bails out the banks lending is loosened up again from the commercial side. However GSE’s (Fannie Mae, Freddie Mac) can still and do lend out money during these periods for what ever interest rate they desire, (they may desire to set an interest rate or if they can sell your mortgage as a bond use the international bond market as a guide). GSE’s can always lend because they are really part of the government and this is the historical technique in which the government extends home loans during a crisis. The government can print money, so they can always offer loans at what ever interest rate they desire.
The government then takes these bad loans it has purchased at full price from these banks and either restructures the loans, or liquidates them for a loss in which the government absorbs (this means you the tax payer absorbs).
Now this by itself will not cause hyperinflation. You are creating more money, but this money is not in circulation and is still trapped in the bank loan system. The money goes from one loan to another, out of general goods and services we buy every day.
So what is the bridge to inflation and hyperinflation? Now you are really in for an education.
The US lowered the lending standard to almost zero in order to create money through lending which would cause the price of assets to increase. When home loans lending standards are reduced, then this lending will naturally go towards homes. This has lead to a massive industry build up in construction and employment. Not only house building, but mortgage specialist, brokers, realtors, additional phone lines, inspectors, material cost increase, people are working, GNP rises.
Without the continued appreciation in housing a huge amount of people will not be able to find employment. This causes social programs to become invented to keep people working. Italy did this before WW2 using the military as an excuse. Therefore government spending is now focused onto salaries and social programs.
This action, which has happened during every major banking crisis in every single country in the last 100 years, is what causes hyperinflation to take root. It is the creation of new money after your country can no longer borrow any money which causes hyperinflation. As inflation rises the banks go into crisis again as they cannot make ends meet any longer on 7% interest.
It is government which causes this positive feedback loop in money creation which gives rise to hyperinflation.
Now why couldn’t the US borrow even more money to bail out housing and that be the end of it. Why wouldn’t the other countries lend up more money? They always have, why not this time?
As the US dollar is the worlds reserve currency, central banks all over the world use our currency as the basis for creating their money. When we inflate, they must inflate.
Therefore if we go into a banking crisis, so does the rest of the world. Therefore if we did borrow money this would only be newly created money from these countries that basically just created. This has the same effect as if the US created the money ourselves. It is just importing inflation through increasing the money supply.
Also countries must have faith in the US dollar. During the last banking crisis the world’s currency was not the US dollar, but the British pound sterling. That banking crisis called the Great Depression ended the British pound sterling as the world’s currency. This crisis would definitely put a damper on the US dollar to hold that exclusive title in the future.
Chromatic Dispersion
I forgot to mension that I would expect to see deflation after the banking crisis in respect to you income year over year.
So for example housing cost 50% of your monthly income, I would expect this to fall to lets say for argument 30% of your Year over Year income.
Deflation is all relative.
So if you now make $1 million per year, a loaf of bread may cost you $1,000.
Can you explain the followings:
1) In 1929 depression, money stock fell so less, i.e monetary deflation was so less - yet, prices of many commodities fell more than 60%. Why did they all fall so much if money stock did not fall that much?
2) Japan not only allowed their bank to hold their bank loans - they allowed them to survive with bad loans!! They were able to do this with their saving (i.e forcing the people saving into bank levitation). How can US do it with no savings?
3) Are you assuming, govt will just take the bad loans from the banks to fed accounts? If so, can you tell me how the following can be avoided: Everyone in US quits their job and applies for a loan and then writes it as a bad loan to the bank and then passes it to the fed account. They do this repeatedly again and again. After all, isnt this the most capitalistic way of making money if fed is willing to take the bad loans and banks are "fighting" to give you tons of money? You wont have anyone working in fields, offices, banks - and hell no one working in FedReserve!!! Is this what the FederalReserve do? They will invite every enterpreneur in US to apply for loan and then "if" they default - wink - wink - dont worry? - I've found not a single hyper-inflation believer to provide answer to this profound question!! It is precisely for this reason BoJ did not take the bad loans from the bank books!!!
4) The helicopter money was not first mentioned by Ben Bernanke. It was actually mentioned by Keynes in 1929s!!! He said, banks should leave "jars" of money is street corners so that enterpreneural boys and gals will "pick" this money and create jobs!!! Do you know why the banks did not do this in 1929? The answer is simple - people will take the money of jar - but that is what everyone will be doing - for a living!!! The only job in US will be collecting these jars!!!
Can you explain if this is what Fed wants to do?
5) BTW, for some unknown reason- people are thinking helicopter money will be coming when the deflation hits. But, they fail to understand that - helicopter money is actually happening NOW!!! Now, the population is collecting the jar of money!! And Bush has passed bankruptcy protection law so that the citizens dont fail (akin to war reparations defaults were not allowed in the 1929 depression)!! Why wont they allow bankruptcy filing? Then everyone will take up the "collecting jar" job!!
6) Can you tell me any other way the fed can print money and allow the people to default and still have money pass to the defaulting people/business?
Thanks,
Jay
Thank you for your detailed reply chromatic. I am still trying to understand it all, but when life-science majors like me are able to spot serious global financial instability, you KNOW something is wrong! LOL Thanks again
Chromatic,
I have a few questions from your post.
You said:
"However, the banks get bailed out by the government. This means that the government purchases the bad loans from these banks. Where does the government get the money to do obtain these loans? It (1) borrows the money, (2) uses tax money, or (3) creates money through the Federal Reserve."
(1) Hasn't the government already been doing this? We have continually "borrowed" from Japan, China, and the ill-defined "Caribbean banking centers" through their purchases of treasury notes.
(2) Where are we going to get increased tax revenue? It sounds as if the alternative minmum tax is going to be eliminated pretty soon, wiping out about 1.2 trillion in tax revenue over ten years. With wide-scale mortgage defaults, the new bankruptcy laws kicking in, and significant job losses stifling the economy, where is the tax revenue going to come from? I see a major LOSS in tax revenue. Not to mention, this will be occuring during a major increase in social welfare programs
for all of the unemployed.
(3) Sure, the government can create money, but as has been elucidated above, I don't see how that money will directly (or quickly) ease bank lending standards, where the economy needs it most.
"However GSE’s (Fannie Mae, Freddie Mac) can still and do lend out money during these periods for what ever interest rate they desire, (they may desire to set an interest rate or if they can sell your mortgage as a bond use the international bond market as a guide)."
You are assuming that Fannie Mae and Freddie Mac will not fail, which due to their IMMENSE debt exposure compounded by derivatives, is a HUGE assumption. Remember LTCM? Do you really believe the US could bail the GSE's out? Not to mention, there is NO explicit guarantee of any bail-out by the US government, anyway.
Jay,
Long email, I shall try to answer the question accordingly.
Can you explain the followings:
1) In 1929 depression, money stock fell so less, i.e monetary deflation was so less - yet, prices of many commodities fell more than 60%. Why did they all fall so much if money stock did not fall that much?
It is true that the money stock did not fall that much during the depression, however great deflation was seen in some areas and not others. Commodities depend upon the ability to use them, production. Therefore during the 1920’s when the country was in a bubble economy many items were produced, and this production demands that commodities be expended. Causing competition for commodities and resulting in an increase in prices well above monetary inflation. This situation is similar to the cost of housing materials today.
When the credit stopped expanding in 1928 and was soon followed by the reduction in consumption. Many products were made and capital had been misallocated causing oversupply and over competition in bubble areas of the economy. Leading of course to a steep decline in production which induces a steep decline in commodities consumption. This sets the stage for a fall far larger than the increase as there was no use for the commodities during a world wide depression. They just sat in warehouses or rotted away.
That is how you get a decline which is far bigger than the decline in the money supply.
2) Japan not only allowed their bank to hold their bank loans - they allowed them to survive with bad loans!! They were able to do this with their saving (i.e forcing the people saving into bank levitation). How can US do it with no savings?
First I don’t think the banks survived in Japan buy holding their non-performing loans with Japanese savings. The government of Japan allowed the debtors not to service their debt on schedule or not at all (i.e. non-performing loans). A common tactic for countries in financial trouble.
The banks now didn’t have the money coming in to service their debt they lent out, so the banks are insolvent, however, banks are always insolvent by this definition (i.e. run on banks and fractional reserve banking), it is only when forced to service financial commitments they cannot pay is when bankruptcy occurs.
Therefore I think the Japanese central bank provided the banks with the ability to services their demand deposits while not requiring that the bad loans be written off or services by debtors. If a bank didn’t have enough money to pay financial commitments outside of the country then the central bank provided the funds.
Why did Japan use this tactic, I seem to remember reading a Band of International Settlements paper on this issue indicating that the Japanese have a large old population which would have been hurt if the currency had hyperinflated. So the Japanese decided to never leave their financial cataclysm and experience deflation.
Not to say that they didn’t try at various times to print their way out of this mess, however the money the public saved went to other countries and out of their money in country circulation. This caused the prices to continue to fall because the money in the country was either out of their banking system, not going towards goods and services, and not towards real estate or equities.
Eventually the Japanese tries to pool these loans as bonds and sell them. I don’t think they were very successful and therefore still have the non-performing loans to this day. This had resulted in a huge weight on the banking system.
I am still doing research on the Japanese situation so I may change my opinion of what happened yet again. The real problem is all the best papers are in Japanese. When I get back into the Japanese situation I shall write about it.
3) Are you assuming, govt will just take the bad loans from the banks to fed accounts? If so, can you tell me how the following can be avoided: Everyone in US quits their job and applies for a loan and then writes it as a bad loan to the bank and then passes it to the fed account. They do this repeatedly again and again. After all, isnt this the most capitalistic way of making money if fed is willing to take the bad loans and banks are "fighting" to give you tons of money? You wont have anyone working in fields, offices, banks - and hell no one working in FedReserve!!! Is this what the FederalReserve do? They will invite every enterpreneur in US to apply for loan and then "if" they default - wink - wink - dont worry? - I've found not a single hyper-inflation believer to provide answer to this profound question!! It is precisely for this reason BoJ did not take the bad loans from the bank books!!!
I like this point about people quitting their jobs. I have written about this phenomenon in the past. What you are describing is going on right now. They are called realtors and real estate speculators, flippers, and day traders. In fact this process has happened many times in US history. That is why the majority of wealthy people in America who created their own wealth have done so in real estate and speculation. This also happened in the 1980’s with the S&L Scandal and in the 1920’s. Flippers, interest only loans, and the whole enchilada.
And if you speculators made a killing in the 20th Century, wait until you see what they did in the 19th and 18th centuries when they could use lending and banking to rob people blind.
Why don’t more people in the US just start taking massive loans out and living off the appreciation. It seems to me a great amount of them are. The rest just aren’t into finance enough to really care.
Why don’t all America’s follow this tactic and reap the rewards of an inflating currency and asset bubbles. Just comes down to basic interest. Some people understand finance, some race cars, some like drugs, some social stuff. It is just how the world works. People are not perfect financial machines, and most no very little about how inflation, loans, or anything else that takes study works. Time and Interest in a subject limits interest. Most people just do what they are told and muddle through life. Look at your own family and tell me they all made good and wise decision all through their lives. It doesn’t happen.
Hate to say this but most people just do not care that much to investigate it. Almost the entire population makes decisions with minimal information and takes almost everything at face value, regardless of what they actually tell you. Just look at the people you work with and try to tell me this isn’t true.
Too much information to know to get through life, too little time to understand all of it or even a good portion of it.
However in order to have an asset bubble as the magnitude we are experiencing now the idea has gotten to the general population that easy riches await in taking out home loans. It has now become part of our popular culture. This entices uninformed people to grow the bubble larger through the fantasy of untold riches.
Ever since paper currency was invented in the West in 1691 the informed have used these bubbles to take buying power from every one else. 314 years is a powerful statement of world events. In the end the people in the know take all the money because they make the rules.
The real question you should be asking yourself, do banks really lose buying power of their money when bailouts, hyperinflation, or deflation occurs. If they make all the rules, they always come out on top.
As our Founding Father Thomas Jefferson stated
I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a moneyed aristocracy that has set the Government at defiance. The issuing power should be taken from the banks and restored to the people to whom it properly belongs.
Thomas Jefferson
If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them (around the banks), will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered.
Thomas Jefferson
4) The helicopter money was not first mentioned by Ben Bernanke. It was actually mentioned by Keynes in 1929s!!! He said, banks should leave "jars" of money is street corners so that enterpreneural boys and gals will "pick" this money and create jobs!!! Do you know why the banks did not do this in 1929? The answer is simple - people will take the money of jar - but that is what everyone will be doing - for a living!!! The only job in US will be collecting these jars!!!
Can you explain if this is what Fed wants to do?
5) BTW, for some unknown reason- people are thinking helicopter money will be coming when the deflation hits. But, they fail to understand that - helicopter money is actually happening NOW!!! Now, the population is collecting the jar of money!! And Bush has passed bankruptcy protection law so that the citizens dont fail (akin to war reparations defaults were not allowed in the 1929 depression)!! Why wont they allow bankruptcy filing? Then everyone will take up the "collecting jar" job!!
Let me cover points 4 and 5 in this response.
Actually Keynes stole the idea from Fisher, the work Keynes is based upon. As a historical note Fisher went broke.
The answer to this question is really a question about the US dollar role as a world currency and understanding what this means. It means that all other currencies use the US dollar as a basis for expanding their own currency base. This has been in effect since the US dollar took over as the world’s currency from the British pound sterling in the 1930’s.
The world has had only a little over 100 years of nationalized paper currency. Therefore it has taken this long to see its end. The push for nationalized money comes from the great socialist movement born in America in the 19th Century. This is how government has increased its roll in our lives.
Washington DC is full of Technocrates, PhD’s who love to be in charge of social planning. In this way they gain power and importance.
Are we in the New Deal now. Yes, it is called the war on terror. It is keeping American’s employed.
Seems to me the new bankruptcy laws have been invented for one purpose, to enslave the American people for up to 5 years at a time. Now this is growth in state power.
What does the Fed want to do?
The Fed is going to do what it was designed to do, inflate the currency. Read something about the Fed and contrary to popular belief it is here in order to inflate the currency.
In the book the A History of Money and Banking in the United States Murray Rothbard writes
“The campaign for a central bank was kicked off by a fateful speech in January 1906 by the powerful Jacob H. Schiff, head of the Wall Street investment bank of Kuhn, Loeb and Company, before the New York Chamber of Commerce. Schiff complained that in the autumn of 1905, when “the country needed money,” the Treasury, instead of working to expand the money supply, reduced government deposits in the national banks, thereby precipitating a financial crisis, a “disgrace” in which the New York clearinghouse banks had been forced to contract their loans drastically, sending interest rates sky-high.
An “elastic currency” for the nation was therefore imperative, and Schiff urged the New York chamber’s committee on finance to draw up a comprehensive plan for a modern banking system to provide for an elastic currency. A colleague who had already been agitating for a central bank behind the scenes was Schiff’s partner, Paul Moritz Warburg, who had suggested the plan to Schiff as early as 1903.
Warburg had emigrated from the German investment firm of M.M. Warburg and Company in 1897, and before long his major function at Kuhn, Loeb was to agitate to bring the blessings of European central banking to the United States”
6) Can you tell me any other way the fed can print money and allow the people to default and still have money pass to the defaulting people/business?
This has happened many times and every few years somewhere on the globe. When a government promises more than they can borrow, then they just print money. When a government looses the ability to borrow more any international money, and they still keep their promises of social programs and all of the other socialist/ communist things that governments promise to keep in power a few things happen.
The money in circulation skyrockets causing inflation as governments are forced to pay out money by the threat of political and social instability. However this creation of money is first multiplied by the bank, then the commercial banks stop lending as interest rates skyrocket upwards forcing the government to bail them out.
Next the amount of money created causes prices to go upwards and hyperinflation ensues. Argentina just went through this.
Countries can go through many cycles of hyperinflation before any length of stability is reached.
Therefore to answer your question, how does the government still have money to pass to the defaulting business, they can just order the Federal Reserve to monetize the debt (create money) to facilitate this function, however this will ultimately lead to hyperinflation.
In fact the US has a very long, 300 year history of such actions, by the way these regions in the US went through hyperinflation. Just look to the massive public works projects in the 19’s Century and every single decade.
Hope this helps.
Chromatic Dispersion
Here you are
You said:
"However, the banks get bailed out by the government. This means that the government purchases the bad loans from these banks. Where does the government get the money to do obtain these loans? It (1) borrows the money, (2) uses tax money, or (3) creates money through the Federal Reserve."
(1) Hasn't the government already been doing this? We have continually "borrowed" from Japan, China, and the ill-defined "Caribbean banking centers" through their purchases of treasury notes.
The Fed is always bailing out banks, therefore some of this money could have been used for that purpose, but I rather think it went to the War effort and social programs. At the rate of increase I would expect the entire GNP of the country couldn’t even service the interest on the debt.
An interesting note is that once money can no longer leave the US through economic troubles or whatever, this will increase the money in circulation. Right now a lot of the money which would be causing further inflationary pressures is leaving the country through our negative trade balance. Of course this money comes back as credit for mortgages, lifting prices higher and reducing interest rates.
(2) Where are we going to get increased tax revenue? It sounds as if the alternative minmum tax is going to be eliminated pretty soon, wiping out about 1.2 trillion in tax revenue over ten years. With wide-scale mortgage defaults, the new bankruptcy laws kicking in, and significant job losses stifling the economy, where is the tax revenue going to come from? I see a major LOSS in tax revenue. Not to mention, this will be occuring during a major increase in social welfare programs
for all of the unemployed.
I would expect, before wages start to rise induced through inflation, that tax revenue shall decline. I have states this before. This by the way in no way precludes hyperinflation as every single country to have gone through hyperinflation has had their tax base drop from under them.
(3) Sure, the government can create money, but as has been elucidated above, I don't see how that money will directly (or quickly) ease bank lending standards, where the economy needs it most.
"However GSE’s (Fannie Mae, Freddie Mac) can still and do lend out money during these periods for what ever interest rate they desire, (they may desire to set an interest rate or if they can sell your mortgage as a bond use the international bond market as a guide)."
You are assuming that Fannie Mae and Freddie Mac will not fail, which due to their IMMENSE debt exposure compounded by derivatives, is a HUGE assumption. Remember LTCM? Do you really believe the US could bail the GSE's out? Not to mention, there is NO explicit guarantee of any bail-out by the US government, anyway.
Fannie, Freddie, or something like the Resolution Trust Corporation or the Home Owners Loan Corporation, I would expect to see the GSE’s in operation even through insolvency. In every single major banking crisis for over 200 years governments have suspended property rights in order to keep their banks alive. I don’t think this will change.
The bond holders shall be paid back, just in deflated currency. Even if the government allowed Fannie and Freddie to die, what is to stop them from starting a RTC or HOLC again. Nothing, nothing at all. But I really don’t think we have seen the end of Fannie or Freddie, just like always creditor to banks property rights shall be suspended. If no one want to buy their bonds, and during a world wide banking crisis I could easily envision this, then they will just sell the bonds to the Federal Reserve or Treasury.
Chromatic Dispersion
Chromatic,
Thanks a lot for your detailed explanation. One thing you did not explain is: What happens if people quit their job and take loans and default on it? Currently, people are taking loans AND also assuming the RISK associated with asset depreciation. The risk they are taking is that - they will have to pay later!!! And so far, Fed has not taken bad loans!!! So, if FED does it, ONLY THEN, we can see this problem happen. And I can bet you, lot of people today are not buying homes because they think it is risky, some think they can not afford etc. If FED is willing to take as much bad loans banks can create, What will stop banks from issuing tons of more loans? And what will stop people from taking these NO RISK loans (because fed is willing to take this back). If this happens, I am extremely convinced, even a 1 month old baby will apply for loans and pass the bad loan to FED. In such a NO RISK environment, you will not find any other job existing in the market/economy!!! You dont need interest or knowledge to do it!!! It is a guaranteed MILLION dollar winning lottery ticket!!! Dont you agree? Do you think, if people become aware of GUARANTEED million dollar lottery, dont you think everyone will play it whether they have interest or economic knowledge? I believe this is why BoJ did not take the bad loans!!!! It is not that BoJ is afraid of foreigners dumping yen - but it is the Japanese who will quit their jobs!!! Dont you agree??
Also, in 1929, not just commodities, even food prices and essentials fell a lot ( greater than 50%) in price. I believe the reason is that: All though huge amount of reserves were maintained by the FED, the banks were not FULLY loaned. In murray rothbard's AGD, you will see that, the excessive reserves about 30Billion or some 30% (I dont know which one) was held as reserves!! In other words, all though reserves were high, money supply into the financial/real economy was curtailed by more than 30%!! That is why there was deflation in food and essential items!! This is exactly what Keynes called as "Liquidity trap". i.e there was tonnes of liquidity in reserve - but NO ONE borrowing!!!! This is what causes deflation!!!!
In other words, banks will not loan new money to any one (because people are defaulting). Why does this matter to banks? Today, banks are making huge profits in these loans. So they are reporting lot of earnings per share and hence the ceo and the top guys are getting lot of money. Once defaulting happens, the profits reported by banks will take a huge dive!! So will the CEO and the top guys bonus/salary!! Now, the CEO and others being selfish, they will start cleaning up their balancesheet - in other words "liquidity trap"!!! So what has happened now is that, banks have pulled their future profits into their current year - so they will show loss or no profit in the future!!!
If FED is willing to take the bad loans from the banks - you are not understanding one important aspect: The bank ceo - just one guy - will take a TRILLION dollar loan to buy some hedge fund etc - and then declare that loan as bad loan and pass it to FED. Do you think, Congress will allow ONE guy to take a TRILLION dollar loan that easily just to protect the economy? How about other CEOs? Even if you assume the general populace is ignorant - do you think the CEOs will be content with JUST 1 TRILLION? Why wont they go all the way to 100 TRILLION?? Why are you saying this is exactly what is happening today? (when you say, today real estate agents are doing it currently!!). It is not happening today. It will happen ONLY if FED is willing to take the bad loans. This will not happen for the simple reason, CEOs of banks, the knowledgeable people will take 100 TRILLION dollars loan and pass it to fed as bad loan!!! Are you defending this is what FED will allow to happen? Ofcourse, you might argue, fed will put a cap for 300K per person - Then the CEO will create 0.25 TRILLION fake bad loans equivalent to 299K and then pass it to FED!!!! Are you defending that FED will still take the bad loan - and create ZERO RISK for taking loan?
Finally, the only way the fed can help is reduce the interest rate (as opposed to taking bad loan) - Ofcourse, I can post the consequences in a separate section. So, in short deflation is in the cards - AS LONG AS FED CAN NOT CREATE ANOTHER ASSET BUBBLE!! I'm not sure if there are anymore assets going forward!!
I have posted my response on the main blog page.
Chromatic Dispersion
Hello Chrom ic Dispersion , Als je bij een bank niet slaagt voor een hypotheek heb je dan nog kans op een hypotheek bij bijvoorbeeld postkrediet?
Hello Chrom ic Dispersion ,Als je bij een bank niet slaagt voor hypotheken heb je dan nog kans op hypotheken bij bijvoorbeeld postkrediet?
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