someone help me understand this better and what exactly it means. i have only glanced at this guy's blog but a lot of what he says sounds pretty straight forward. http://market-ticker.denninger.net/archives/703-Uh-Oh.....-Monetary-Flat-Spin.html That has gone "just below" 1.0. What is this? I could go through the derivation of how money supply works in a fractional reserve monetary system (any), but won't, because most readers would have their eyes glaze over. The important part of this graph is what it denotes. Bernanke has lost control of "N" (or velocity), which is the actual knob that he is trying to diddle when borrowing rates are changed (and in fact its the market that sets that, despite his protests.) In fact the most useful tool in The Fed's box in terms of influencing monetary policy is the soapbox, that is, jawboning (whether it be by cajoling or threatening.) The problem with an M1 multiplier below one is that the effect of printing money is of course multiplied by the velocity. That is, if you print up $10 into the economy the impact it has on economic activity depends on how many times that $10 circulates in a given amount of time. The more it circulates the higher the impact and the more your efforts do for the economy. The bad news is that when the multiplier is less than one the more money you spew into the economy the worse the impact, as you get less for each additional dollar. If you remember the "GDP for each dollar of debt" graph.... M1's multiplier going below 1 strongly implies (but does not yet prove) that we have reached that "zero hour". Why? Because all money is in fact debt; this is inherent in all modern monetary systems. When Bernanke "creates" money he is doing so against an asset - that is, he is issuing debt. A Federal Reserve Note (whether electronic or paper) is in fact effectively a bond of zero maturity and indefinite expiration against the future tax collection capacity of The United States. That is, it's a treasury bond (via a circuitous route) The paradox that Bernanke is in danger of discovering (the hard way) is the paradox of a pilot who finds himself in a flat spin. As the ground approaches he wants to pull back on the stick but if he does so, the spin simply tightens as the wings are not producing lift - the angle of attack is too high, not too low. As such if he does what his brain screams at him to do instinctively, he dies. Or the scuba diver who sucks on the reg and gets nothing. Your instinct is to hold your breath and kick for the surface. If you do it you die. In both cases your only hope of survival is to do exactly the opposite of your instinct. In the case of the pilot you must not only give counter-rudder (to stop the rotation) but also push the stick forward. In the case of the diver you must exhale that last breath you have in your lungs, knowing there are no more in the tank while you kick to ascend. If you succumb to instinct you are dead. Really dead, as in splat (or exploded lungs.) Bernanke is effectively in the same box. The foundation of his entire thesis as a banker is that a central bank can always reverse a deflation by printing money. Unfortunately as he has done so velocity has fallen and the multiplier has now gone below 1. If this induces him to do even more of what caused this decrease there is a very real risk that the actual market reaction will be to tighten the monetary flat spin. This is because the underlying problem in the economy isn't the lack of debt (money) in the system. It is that there is too much debt of all sorts, and since money is in fact a form of debt, you can't fix the problem by playing helicopter drop! As I have said for more than a year the only way out is to force the bad debt out into the open and default it. Yes, this will produce bankruptcies - lots of them, including some for "inconvenient" people like Paulson's buddies on Wall Street. But until and unless that happens adding more debt to the system depresses the multiplier effect of that debt on circulation further, and harms, rather than helps the situation. I don't expect our government officials to understand the math on this, nor would trying to go through it help 99% of the readers, but unfortunately, mathematics is the only true science - and you can't twist it, no matter how hard you try. Bernanke knows this at an intellectual level, just as the diver - or pilot - knows that if he holds his breath (or pulls the stick) he is going to die. The question now becomes whether Bernanke can overcome not only instinct but also political pressure to do the wrong thing and instead use his intellect - and the math - to do the right thing. What is the right thing? Paradoxially, it is to withdraw liquidity and by doing so force the bad debt into the open where it does (and must) default. How far can the above ratio contract before we cross an "event horizon" from which there is no escape? I don't know. But I do know that there is a "too late" point, as there is for all such things, and that we are approaching it, as I have been saying for months. BTW, evidence that Bernanke's Monetary Flat Spin is already impacting the economy in ways that may do critical (if not fatal) damage was found this morning in the Case-Schiller numbers. Everyone, including Bernanke, was expecting the rate of home price declines to start to slow in the second half of the year. Instead, they accelerated. We're in uncharted territory folks, and the forecast is for dark-and-stinky storms. Buckle up. PS: Congress, and the rest of America, can't say they weren't warned. There were - right here.
thanks for the heads up on that blog. some interesting stuff. I don't buy the full doomsday predictions, but the reality is, much like our Rockets, we are all in a world of hurt.
robbie380- everyone in America needs to read this. This is exactly what we are doing and the best overview of our situation. This thread should be repeatedly bumped until it is understood.
i guess i actually understand what he is saying but it doesn't really register with me since everything is screwed up now.
I was thinking about posting some of Denninger's stuff....good reading. He certainly paints a rosy picture for 2009
LINK??? Sounds like propaganda to me. Government official are so dumb. I guess investment bankers are always so smart. Sounds like just more economic fundamentalism to me. Very interesting, though.
Sounds like Bernanke's running out of time to fix it with boatloads of money before our crisis mirrors a financial crisis from an emerging economy. Thanks for the read.
How does that actually work? A bank goes to the Fed, borrows a dollar, and turns it into $0.96? I just don't get how this can logically happen. I can see how it would get to 1.0, if banks were just borrowing and adding the money to reserves. I don't get how it can go below 1. On the other hand, the $.20 of GDP growth for each $1 of government spending sure explains the huge numbers that we've been seeing lately.
Someone else can explain this better but, a simple version would be we grow our economy through debt. The banks make their money by making loans on fractions of assets. So if a bank borrows $10 from the Fed if they are able to loan it out they can book the loan as an asset. This increases the amount of times they can loan the $10. Thus it produces velocity in the economy because it can be loaned several times and each time it can be booked as an asset. Increasing the debt infusion into the economy. As long as the loans don't default or the banks don't engage in high risk derivative products that can swamp them, a bank could make tons of money by fueling the economy with debt. Apparently the velocity of debt is slowing alot. In other words the banks can borrow more from the Fed but the pipeline of easy credit into the economy is narrowing down to a funnel.
The "velocity" problem, if I understand it correctly, is simply that the money isn't circulating. People are stuffing it under their mattresses, figuratively speaking. Bernanke is trying to bet that if he forces enough money into the system, it will eventually start to flow somewhere. Now the game plan is to basically use the government as a catalyst through massive infrastructure spending. The market needs a leader for investors to start putting cash to work again, and they're hoping that they can create that leader. It doesn't solve the debt problem, but here's my problem with the "force bankruptcies" solution: right now we simply do not have the visibility and transparency that is necessary for an orderly restructuring of the system. The reason why the system nearly collapsed in October was that there was all this wild speculation of how much worthless capital was in the system, but nobody really knew how much or where. TARP was supposed to help fix that problem but it hasn't been well executed, and until that problem is fixed, any attempt to puke the bad debt will likely cause more irreparable damage to whatever good was left in the first place.
Bank goes to Fed, borrows $1, but only lends out $0.96, reducing the amount of actual money in the system... Note the period of time at the beginning of the graph where the Velocity multiplier was over 2, this meant that when the government lent (or a customer deposited) money to the bank, that money would turn into 2-3 times as much in loans, increasing the amount of liquidity in the system.
This isn't quite right - that only works if the borrower then just sits on the $0.96. If the borrower then buys something with that money, it goes to another bank account, from which it can then be borrowed again, etc. That's how the money can multiply. I'm guessing one of a few things would be happening here: 1. The bank is only lending out a slight percentage of what they get so that even wheh the money multiplies, it totals to less than the original money. 2. The lines that lenders are closing are larger than the new loans they are opening. 2. The borrower is "spending" the money on things like paying down debt, which doesn't expand the money supply unless the debtor then loans the money elsewhere. If the debtor just collects the money and holds it, that shrinks the money supply. Overall, I'm not sure there's any kind of fundamental long-term problem with the Fed's ability to expand the money supply. I think this is more of a short-term thing where the money being put into the system is being overwhelmed by credit lines being closed or debts being written off. Once (or really, if) that process stabilizes, I would imagine the money multiplier would start growing again. If it doesn't stabilize and banks aren't willing to lend or new loans continue to be overwhelmed by defaulting loans, then we're screwed.
I know, just trying to simplify. Here is an expanded discussion... http://en.wikipedia.org/wiki/Velocity_of_money Basically, Velocity tries to measure how many times a dollar is spent in a given time period (usually a year) and using the $0.96 measure, each dollar is being spent less than once a year where in previous years, that number stayed above 2 pretty consistently.
Gotcha. I think what's actually happening here is that the new dollars are being circulated just fine (2x or whatever), but at the same time, other dollars are being sucked out of the system, so the net effect is negative. If that were the case, then that would suggest if the Fed were to try to expand the money supply more aggressively, you'd still have a net positive effect. (If what the original article is implying is correct, then that wouldn't be the case)
There are so many people in damage control mode (my father is planning to work until his IRA recovers) and simply paying off their debt or "going to the mattresses" until this whole mess starts to work out. Ultimately, I think it will end up being a net positive for this country as we have been relying too much on credit, but some people are going to get chewed up in this mess.
Aren't both reserves and loans counted in the M1? So in your example, the $1 would have increased the M1 by $0.96, making the M1 multiplier 1.96, even if the borrower stuffed his loan in a mattress? Major, I can see how this could be an anamoly with the way the numbers are calculated, but if we take the number at face value (and I think Denninger has been afforded that), I still don't get how it works.
I think I read the answer in one of the previous posts. If the borrowed Fed money is going to pay down other debt, and the money received by the creditor isn't loaned back out, that reduces the money supply by the interest rate. I guess that makes sense. I'm not completely sure.
If you look at the graph, though, it suggests it is an anomoly. The multiplier moves relatively slowly - because behavior across the entire US economy just doesn't move that fast. Yet beginning around Sept or Oct of this past year, the multiplier falls off a cliff. That suggests something other than the Fed's actions being involved here. It happens to correlate to exactly when banks started panicking - when they stopped lending, started pulling back lines of credit, etc. So to me, that suggests that it's the temporary bank activity that's causing this. Once the banks stop their panic, it would imply that the multiplier would go back to normal and the Fed can still use that as a monetary policy tool. As to your original question of how the multiplier goes below 1 - that's the pulling of credit lines. Let's say the Fed injects $1 into the system while a bank is not re-lending $1.05 they got in credit payments - the net effect is your $1 turns into $0.95. But it's two separate and unrelated actions - so my thought is that if the Fed was injecting less money into the system, that multiplier would be far lower because you'd have less new money circulating but banks still closing and not renewing old credit lines.
Open, but inactive lines of credit aren't part of the M1 (or any measure of money supply). Paying off a line of credit reduces M1. Closing one doesn't. (From wikipedia: M0: The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency. M1: The total of all physical currency part of bank reserves + the amount in demand accounts ("checking" or "current" accounts). M2: M1 + most savings accounts, money market accounts, and small denomination time deposits (certificates of deposit of under $100,000). M3: M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements. ) According to the actual data, the "fall off the cliff" part of the graph happened between 9/10 and 9/24, right after the bailouts started.
Certainly - but open lines of credit can be used. Closed ones can't. For example, I have a small business. We had a $15k AMEX credit line. We paid it off every month - no problems, no issues, nothing. Last month, they cut it to $5k for no reason except that they were cutting back lines of open credit everywhere. We had many months where we'd go over $5k in a month. Also, in talking about "closing lines of credit", I also meant that when a line of credit is paid off (say, a mortgage), another one isn't opened to replace it. So the bank is just reducing their total credit exposure - I should have been more clear there. Lehman Brothers collapsed on 9/16. The bailout didn't actually pass until a few weeks later (early October, I believe). The reason for the bailout, though, was that the credit markets started seizing up in that period of mid-September. So the beginning of the "fall of the cliff" actually correlates to when all hell started breaking loose in the credit markets. And then all throughout the 4th quarter is when banks started pulling credit lines and credit was hard to come by. I think October/November is when car loans were super-limited, for example. That said, there are signs of stabilization, so if my theory is right, you should see that multiplier stop falling and maybe move back up over the next few months.
