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We had a good discussion on the concept of money developing after the last
three posts. Here are a few of my comments, re posted by request:
_________________________________________________________
This first one was a response to a question about a potential dollar rally
during another global liquidity crisis...
Hello Anonymous (6:05PM),
Here are some thoughts and comments as you requested:
We need to keep a few principles in mind in order to understand what is being
discussed in these confusing discussions about a liquidity crisis, currency
swaps, and supposed dollar strength. My apologies if I simplify this too much
for your taste, but my thoughts are simple ones...
1) First of all, what are all banks and bankers afraid of? A run!
2) Hyperinflation coincide with a multiplication of the monetary base (which
is the natural response to the market devaluing "broad money",
near-cash credit assets), not with the credit expansion of broad money
through commercial bank lending.
3) The USDX measures the supply and demand of actual base money needed for
transaction clearing, not the willingness of banks to stick their necks out
further. Base money is the "reserve" in the term "fractional
reserve banking". We could call it "fractional base money
banking".
4) Currency devaluations are long term and permanent. USDX quotes are short
term and temporary.
5) There is no difference between the $ and the $-financial industry ($-FI).
What is bad for one is bad for the other. A run on the system is just as bad
as a run on the banks, or a run on the dollar. Any run screws them all.
6) Much of what we all think of as money (dollars) is not really dollars in
the same sense as the dollars needed in a liquidity crisis. We think of money
mostly as M2. But a liquidity crisis requires MB (Monetary Base, or base
money)
7) "The system", meaning the worldwide financial industry is
divided into sub-systems; The Federal Reserve system, the Eurozone system,
the British system, etc... What differentiates these sub-systems from one
another is their own currency, which can be created on a whim by the central
bank and lent to banks that need extra funds with the CB taking collateral
from the borrowing bank in the form of assets denominated in that currency.
8) Each sub-system is a completely interconnected network of financial
institutions, including commercial banks, investment banks, brokerages,
etc... 99% of all transactions within each sub-system clear without ever
having to move money (dollars). For example, within the bigger banks, most
transactions clear in-house. One person might buy a house, taking out a new
loan for $100,000 while some other bank customer sells his house paying off his
$100,000 loan. These two transactions cancel each other out in-house.
Inter-bank transactions cancel each other out as well. For the most part,
finance and banking is a zero-sum game within each sub-system, from stock
transactions to bond transactions to new loans to settled loans to you
writing a check to your dentist. If one bank ends up with more at the end of
the day and another with less, then the central bank clears the trade with a
book entry transferring "reserves" from one bank to the other. Even
new loans do not really create the kind of money that is needed in a
liquidity crisis. They create credits issued by the bank, liabilities that
are counterbalanced by the debt papers you signed. Those credits entitle the
bearer to dip into the bank's actual dollar reserves, but do not create new
dollars. The only new dollars that get created are when the bank must move
funds to cover fractional reserve requirements. Those funds then become new
monetary base. THOSE are the kinds of dollars needed in a liquidity crisis.
9) Each sub-system has a TREMENDOUS amount of flexibility since the CB acts
as the ultimate clearing house between all the financial institutions in that
sub-system. And since we are now on a purely symbolic fiat currency, the CB
can create any liquidity the system needs. If one bank comes up so short at
the end of the day, owing another bank more reserves than it has, then the CB
just creates new reserves and lends them to the bank that is short and the CB
takes assets (from the borrowing bank) onto its own balance sheet to
counterbalance and collateralize the loan of fresh new money. This
flexibility has virtually eliminated all banking liquidity problems within
any given sub-system. Only an actual bank run on physical cash within a
sub-system presents a real threat. And if that run happens to only one bank
in that sub-system, then that bank is sacrificed. If a sub-system-wide run on
cash were to happen, we would have a bank holiday while they figured out the
best way to devalue the monetary base and increase it.
10) Viewing the whole worldwide financial system, in which the BIS acts as
the ultimate clearing house, there is much less flexibility because the BIS
does not print the currencies it clears. The BIS would prefer ITS central
clearing to be done in gold bullion, stored in its vaults and moved from one
countries slot to another when necessary. But the $-system doesn't want to
play that game. Even still, 99% of the worldwide transactions clear without
the need to transfer any funds around... as long as it is a "business as
usual" day.
11) Problems start to arise in the international clearing house when daily
transactions become unbalanced, meaning too many people trying to do the same
thing all at once, with no one willing to do the opposite thing. The two
sides of a zero-sum game are never in perfect balance, but they are usually
close enough that market pricing takes care of the difference. (If there are
too many sellers then the price drops until the sellers equal the buyers.)
But sometimes an event happens that spooks the markets and sends everyone to
one side of a trade all at once. Prices go into free fall which spooks the
markets even more. Then the exchanges are shut down "to let cooler heads
prevail". But this only spooks the market further. Finally, at the end
of the day, the clearing house is left with a big one-sided mess to clean up.
12) Here is the big problem. Each of these sub-systems has its own currency
which its CB can print at will... flexibility! But with the dollar being the
global reserve currency, there are lots and lots of dollar-denominated assets
held by financial institutions in many non-$ sub-systems. So when there is
turmoil in the dollar-denominated markets, the non-dollar sub-systems run
into a clearing problem because they can't print dollars to help banks that
owe other banks more dollars than they have. So they turn to the BIS, who
also can't print dollars. Only the Fed can. So the Fed ends up being the de
facto CB to the world. But it is not the clearing house for the world, and it
does not take assets onto its books from those foreign banks that got into
trouble. Instead, it lends directly to the other CB's which print some of
their own new currency and send it to the Fed in exchange. This is why it is
called a "swap" instead of Quantitative Easing. They are swapping
freshly printed currencies instead of assets for currencies. All base money!
The same as cash. TWICE as potentially inflationary as QE on a global scale
because two sides are now exposed to currency risk.
13) When the Fed makes these international currency swaps, it doesn't send
pallets of hundred dollar bills on a plane. It simply makes a contract with
the foreign CB and a book entry. The contract is a two-way promise to later
provide pallets of physical cash if anything goes wrong and cash is needed.
And with this promise in hand, the foreign CB makes a similar contract
(promise) with the European bank that got in trouble. The foreign CB promises
to later provide physical cash if necessary (if something goes wrong), and
the bank submits assets to the CB as collateral. Next the troubled bank
passes those dollar promises (IOUs) on to the bank it owes the dollars to and
that bank credits its customer's account with dollars it doesn't have, but now
has indirect access to (if needed). The idea is that as things return to
normal and transactions start clearing in a more balanced state that
ultimately the dollars that were needed will be able to be gotten on the open
market without causing a spike in the price and they can work their way back
to the foreign CB. The troubled bank, for example, can later trade assets for
dollars and pay back the foreign CB which will then pass those physical
dollars on to the bank holding the IOU. And now that the European problem has
been cleared, the foreign CB can cancel that portion of the two-way swap
agreement with the Fed. And no physical dollars need cross the ocean. And
that portion of the currency risk is eliminated.
14) Base money is either physical cash or a liability (IOU) that traces
directly back to the Fed, which includes reserves held at the Fed. In other
words, it is physical cash, or the promise of physical cash from he who can
print physical cash. The Fed is willing to issue these promises willy nilly but
hopes it doesn't actually end up having to do the printing.
15) The USDX is a measure of dollar exchanges with other currencies that
happen on the open market. The Fed can counteract a rise in open market
dollar demand by providing a supply of dollars directly to banks within its
own sub-system, or indirectly to foreign banks through swaps with other CB's.
Last year the Fed had a lot of practice doing this fast. I am sure the
contractual transaction with the foreign CB's took several hours and included
recording video teleconferences in which the agreements were legally bound.
But now that they have experience doing this in a crisis, next time it will
probably be almost instantaneous.
16) So as long as there is more demand for dollars than supply, the Fed can
control the price of the dollar on the USDX by its own willingness to lend
dollars at zero interest with toxic assets or foreign currency as collateral.
This costs the Fed nothing, except currency risk and bad PR at blogs like
mine. But where the Fed loses control is when there is more supply than
demand. And that is what is coming because of this very inflationary policy
of providing dollars to save the system at any cost.
17) The problem is with the assets that are being swapped around for dollars,
whether with the Fed or with the foreign CB's. These assets are becoming less
and less liquid because they are not valued correctly. If they were valued
correctly, the banks would be insolvent and have to file bankruptcy. They
wouldn't even have enough assets to settle their debts by swapping with the
CB's. This is why the assets need to remain marked to myth. But this makes
the assets only sellable to the CB's. The open market doesn't want them. So
the clearing mechanism that is needed to reverse the flow of supposedly
temporary base money into the system is breaking down. The Fed tells us with
a straight face that it can reverse everything it has done so far. But that
is only the case if the free, open market is willing to take up all the slack
the Fed put out there by private investors buying toxic assets at marked to
model prices.
18) So the next time the Fed has to create a trillion new dollars of
liquidity, it is likely going to stick in the system as base money that
cannot be removed. Ultimately the Fed will be contractually obligated to
print actual bills and supply them to the banks and CB's that hold the
contract for them. And this is what devalues the dollar.
Conclusions: The USDX is a rather poor metric by which to judge the dollar,
even in the short term. As long as there is a demand for base dollars, like
there is in a panic or a crisis, the Fed has total control over whether it
wants to let that demand bid the dollars on the open market, or provide them
itself. And the Fed cares more about the financial system than the value of
the dollar, so it will surely provide any liquidity that is needed.
The next crisis, if it is mainly in the US financial system, will likely not
spike the dollar because the Fed has total control and flexibility within its
own system. If it is spread throughout the world it may spike as foreign
banks bid up dollars on the exchange, but the Fed is now more experienced
than it was a year ago and will likely put a lid on it very quickly.
But this next dollar shock will probably be irreversible, unlike the last.
And in such, it will increase the global supply of dollar monetary base by a
large percent. Perhaps by 100% or more. This alone will devalue the dollar
and be the cause of the next shock which will require a similar response by
the Fed, perhaps increasing the base by another 50% as China and others dump
the last of their bonds onto the open market in a highly one-sided
transaction sending the value of the bonds to zero, US interest rates to
something so high they are non-existent, and the purchasing power of the
dollar down into the stinky, Zimbabwe dirt.
So in short, I guess I agree with David Bloom. Of course it COULD rally, but
I don't think the Fed will let it (unless it happens to have some T-bonds to
sell that week!). Letting it rally too high would crush the financial system
(by driving asset values into the dirt) which the Fed wants to save at any
cost. Even though the cost will be the crushing of the system. The ol'
Catch-22.
Sorry if this seemed a bit simplistic or a little elementary. Of course there
are more complicated issues involved, like the $ carry trade and
cross-currency investments. Derived foreign exchange activities become very
complicated very fast! Too complicated for the banks, obviously! But I hope I
at least covered the basics of the problem, enough to explain my answer. You
all will be sure to let me know if I got something wrong... I am sure of
that! ;)
Sincerely,
FOFOA
PS. This is the big secret that George F. Baker didn't want to tell Congress
in 1913. That most all of what we think is money is really just promises
issued by banks to supposedly credit-worthy entities giving them the right to
withdraw value from a small reserve of actual money, but at the same time
praying to God that they don't! It's like saying, "here you go, it's all
your's, whenever you want it come and get it" with their fingers crossed
behind their backs hoping you won't ever actually "come and get
it".
But whatever happens in the short term, the USDX will ultimately collapse
just as Jim Sinclair says because ultimately is DOES represent a preference
of currencies for use in international trade. And we know where that is
heading, especially while the Fed hyperinflates the MB trying to save its own
precious global $-FI!
_________________________________________________________
And in response to "Then why is the FDIC closing so many banks?"...
Hello Allen,
The FDIC is closing banks because they are insolvent. This is actually a
system-wide problem as so much of the asset base is built upon the housing
and commercial real estate sectors. But the bigger banks are being protected
by accounting rules that let them lie about the value of their complex
derivatives.
The smaller banks still hold a lot of raw mortgages, not yet securitized.
These losses are harder to conceal. Many banks are still lying by not
foreclosing even on badly delinquent homeowners. But this is only making the
problem worse and "kicking the can down the road".
These smaller banks don't have the assets to acquire the loans they need to
cover their liabilities. They are insolvent, just like the big banks, but
they can't hide it anymore, thus they get closed.
This is what people mean when they say, "this is not a liquidity crisis,
it is an insolvency crisis". "Liquidity" means being able to
get money for your assets from the CB (or from the open market).
"Insolvency" means you don't even have the asset values to do that!
Sincerely,
FOFOA
_________________________________________________________
Some comments on Fekete's
latest...
Wouldn't it be great if they just did away with all legal tender laws?
Perhaps they could just keep one stating how they want you to pay your taxes.
But let the courts defend any and all contractual agreements no matter what
they are denominated in. And open the mint to free coinage! Of course this is
all part of the world that SHOULD be, not the one that WILL be. So it doesn't
give us much guidance for preserving (and increasing) the purchasing power we
have NOW.
Isn't it interesting that the legal tender laws came out in 1909, just two
years after the panic of 1907? As Fekete says, they led to the governmental
ability to finance the world wars. But is legal tender really the problem? Or
is it that the people continued to confuse the store of value function with
the other monetary functions? If we now return back to the system of 1906,
are we not returning to a system that has already reached a less than ideal end
several times? Perhaps it would be better to embrace the separation of
monetary functions as this will take away the ability to finance wars the
same as a new gold standard would. Right?
Is it really the forcing of paper to be used as money (medium of exchange/unit
of account) that allows the collective to rob the citizens? Or is it the
conning of people into holding said paper as a store of value?? I think it is
the latter much more than the former. Both to some extent, but more so the
latter.
If people only hold the currency for the short time period of the medium of
exchange function, then there is much less for the inflation tax to tax. The
higher they turn up the inflation tax, the shorter the time people will hold
the paper. In this case, the inflation tax would only be on the difference
between your work contribution to the economy and what you could buy with
your paycheck two weeks later. And the tax base would be limited to the
amount of currency in circulation. But if people hold paper as wealth, the
taxable base is orders of magnitude larger, and the inflation tax can be
administered more slowly and surreptitiously because of the larger "tax
base".
Imagine if every saver in 1909 started holding only gold coins in his
possession as soon as they passed the legal tender laws. The parity between
paper and physical gold would have snapped long before even the roaring 20's.
Roosevelt would have confiscated gold valued in the many hundreds. But people
trusted their governments back then. So it was easy to CONvince people that
it was better to hold paper with a "yield"!
Fekete notes that no one hoarded gold until AFTER war started in 1914, at
which time gold "went into hiding". But imagine if gold went into
hiding in 1909 right after the legal tender laws were introduced. Perhaps
then, there would not have been war at all. Or at least it would not have
been so well funded!
It would sure be nice if Fekete would apply his brilliant mind to this
Freegold concept! But alas, he is advocating for a new gold standard. A
non-inflationary system, so we can all hold the same money we use in trade as
a store of value.
Perhaps the next step in monetary evolution after a period of Freegold will
be the elimination of legal tender laws in certain zones in order to gain
economic advantage. This would likely be followed by the re-emergence of
Fekete's "real bills". Of course I am only speculating way out into
the future.
My point is that I like Fekete's analysis. It has great value! Hopefully he
can help steer the direction that economic study turns as we pass through
this crisis. But what are the odds that the governments of the world will
suddenly listen to Antal Fekete and reverse the course of the Titanic in
time? Zero perhaps? And even if they did, what would be the immediate
consequences? The unintended ones?
My only point is that any superficial differences between Fekete and this
blog boil down to the perspective with which we attack the problem. As you
say, Shanti, "another angle"!
Fekete takes an activist approach while I take a passive one. Fekete would
like to fully remonetize gold, locking it into all monetary functions. I, on
the other hand, can see that we are already in the process of fully
DEmonetizing gold, which will unlock a tremendous hidden value that is
desperately trying to bust out of its shell. In the end, Fekete says that he
wants people to have "the right to park their savings in gold coins, as
they did before 1909." But they DO have that right already! They just
haven't realized how good it will be... yet!
Sincerely,
FOFOA
_________________________________________________________
On "is it possible that most of what we think of FED is
mistaken?"...
Hello Anon,
You are inching closer to the truth than you may think. The whole system is
an elaborate, global illusion. The money itself is an illusion. Why do you
think banks are now offering CD's with no early withdrawal penalty? It is a
gimmick. It is a carefully constructed illusion. The main goal is to keep
people from withdrawing their perceived value from the system. And to create
a believable illusion, they have to say, "look, you can withdraw it
whenever you want". Study the logical reasoning behind Certificates of
Deposit and you will see that a CD that you can close at any time is an oxymoron.
It is a new gimmick for desperate times. The whole system and all Fed
statistics are a gimmick now, to keep you in their system.
FOFOA
_________________________________________________________
And finally, a little bit from FOA...
It is the dollar and all of its flaws that have led us to this place in
history. Because of the dollar's obsession with gold, we are now entering a
period where for the first time the monetary functions will separate out of
necessity. It didn't have to be this way, but now it is. As FOA said,
"To their amazement, it turns out today,
that digital use demand was the best function that supported their efforts
all the while; by increasing the world's use and need for currency. Had they
understood this modern economic function early on, they could have somewhat
printed the currency outright with almost the same result while arriving at
today's destination. They could have let gold float, not to mention they
could have skipped a large portion of the debt build up that will now end the
dollars timeline."
What he meant was that the post 1971 "purely symbolic dollar"
architects thought they needed to cap the price of gold in order to keep the
dollar in use. But in fact, it was the dollar's ease of use in the trade
function that kept it in demand. Not its illusion of being a store of value.
And had they realized this concept then, we could have had freegold soon
after 1971 and the dollar would have lasted well beyond 2010. But instead,
they set in motion a sequence of events that could only end one way, in the
permanent backwardation of the gold market, meaning the emergence of a
physical-only gold market at a much, much higher price, and also the end of
the dollar's use in global trade.
This is where we are today. And as you watch the volatility in the markets
(look a the Dow over the last few days!) think about this statement FOA made
eight years ago...
""""""It's not that
price inflation may erupt --------- It's not that the massive dollar debts
won't be paid--------The risk is; that our money system requires dollar
(goods prices) and debt stability -------- so without said stability the
currency system fails""""""
Without an international floating gold reserve pricing, to balance against
their devaluing debt reserve, the entire dollar banking system can only rely
upon extreme dollar inflation to float it's accounts. Price inflation will
have to be ignored. To this end the group of dollar supporting countries, we
refer to as the dollar faction, has locked itself into a box. It must find a
way to float gold prices"
"The entire dollar
banking system can only rely upon extreme dollar inflation to float it's
accounts."!!! It must ignore the (hyperinflationary)
consequences of this policy and just do it. This is what S(herlock Holmes)
uncovered!
Sincerely,
FOFOA
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