Showing posts with label Inflation. Show all posts
Showing posts with label Inflation. Show all posts
Thursday, October 13, 2011
Tuesday, November 23, 2010
Understanding Inflation Advocates
Understanding Inflation Advocates by Alex Merced
There are two fundamental questions that come up people discuss monetary policy, and peoples views on these two questions which shape what they think policy should be. These questions are:
- Do you expect inflation or deflation as tomorrows problem?
- Do you prefer inflation or deflation?
In terms of these two questions I expect price inflation down the line from the inflation of the money supply which we've seen primarily in bank reserves which I believe has grown beyond the ability for the fed to absorb later on so it's essentially racecar that's revving it's engine before a big race. While I think all manipulations of the money supply have an effect of causing mal-investments in the economy by creating shortages and surpluses of money, if I had to say which is the lesser of two evils I would say deflation. Jorg Guido Hulsmann makes a great case for deflation in his book, Deflation and Liberty.
Although how about the people who prefer inflation, to Austrians such as myself it may seem bizzarre that someone may genuinely think that devaluing peoples savings, and destroying the purchasing power of people on fixed incomes can somehow be good policy. So I thought I'd take a moment to explain some of the inflationists thought process as I understand it.
Why does Price Stability really mean predictable inflation?
Last I checked stability meant constant, so price stability to me would initially mean constant nominal prices but in the world of monetary policy it really means low predictable inflation, generally from 2-4%. Why someone would think this is good policy is primarily psycological. The idea is to create an environment where people feel wealthy cause they think their assets are constantly increasing in value, but really the value generally is constant but it just appears different priced relative to a larger money supply. This approach has some merit to it, but it's based on manipulating the misinformation of peoples views on price increases. As people learn and understand inflation on a larger scale, this should quickly lose any effectiveness as we've seen as people have become more knowledgable in economics the last few years.
This psycological factor is really just a function of the accuracy of peoples education, the 1870s were arguably the most robust period of growth in US history yet it was a period of deflation and generally referred to as the Long Depression. The problem is if people see their assets dropping in nominal prices but don't equate that with increasing purchasing power this can have negative psycological effect, but this only makes the argument for better economic education because growth occured in the 1870s even though people felt negative about their asset values in this era.
There are different ways for deflation and inflation of prices or money supply to occur (depending on which definition your using) which lead to different phenomena. Although the best way to refute someones views on an issue and open them up to yours is to show you understand and empathize with their view more than they do. Knowledge is power, Creativity is power manifest.
There are two fundamental questions that come up people discuss monetary policy, and peoples views on these two questions which shape what they think policy should be. These questions are:
- Do you expect inflation or deflation as tomorrows problem?
- Do you prefer inflation or deflation?
In terms of these two questions I expect price inflation down the line from the inflation of the money supply which we've seen primarily in bank reserves which I believe has grown beyond the ability for the fed to absorb later on so it's essentially racecar that's revving it's engine before a big race. While I think all manipulations of the money supply have an effect of causing mal-investments in the economy by creating shortages and surpluses of money, if I had to say which is the lesser of two evils I would say deflation. Jorg Guido Hulsmann makes a great case for deflation in his book, Deflation and Liberty.
Although how about the people who prefer inflation, to Austrians such as myself it may seem bizzarre that someone may genuinely think that devaluing peoples savings, and destroying the purchasing power of people on fixed incomes can somehow be good policy. So I thought I'd take a moment to explain some of the inflationists thought process as I understand it.
Why does Price Stability really mean predictable inflation?
Last I checked stability meant constant, so price stability to me would initially mean constant nominal prices but in the world of monetary policy it really means low predictable inflation, generally from 2-4%. Why someone would think this is good policy is primarily psycological. The idea is to create an environment where people feel wealthy cause they think their assets are constantly increasing in value, but really the value generally is constant but it just appears different priced relative to a larger money supply. This approach has some merit to it, but it's based on manipulating the misinformation of peoples views on price increases. As people learn and understand inflation on a larger scale, this should quickly lose any effectiveness as we've seen as people have become more knowledgable in economics the last few years.
This psycological factor is really just a function of the accuracy of peoples education, the 1870s were arguably the most robust period of growth in US history yet it was a period of deflation and generally referred to as the Long Depression. The problem is if people see their assets dropping in nominal prices but don't equate that with increasing purchasing power this can have negative psycological effect, but this only makes the argument for better economic education because growth occured in the 1870s even though people felt negative about their asset values in this era.
There are different ways for deflation and inflation of prices or money supply to occur (depending on which definition your using) which lead to different phenomena. Although the best way to refute someones views on an issue and open them up to yours is to show you understand and empathize with their view more than they do. Knowledge is power, Creativity is power manifest.
Friday, August 13, 2010
Labor Economics #1 - Sticky Wages
Labor Economics #1 - Sticky Wages
by Alex Merced
The next few posts I'll be writing will be a series on some aspects of labor economics which will mainly center around wages and upward mobility. In this initial part of the series I'm going to address one of the main Keynesian buzzwords, "Sticky Wages".
John Maynard Keyes (read "Where Keynes went Wrong") makes the admission that it's plausible that an economy can self correct by allowing all prices to adjust downwards if the money supply is reduced for whatever reasons, but contends that there is a problem cause wages are "sticky" so this would make it difficult for businesses to adjust their inventories and prices to maintain the current labor supply since wages won't fall in line with everything else so unemployment ensues. This unemployment will then cause further contraction of the monetary supply causing the economy to just spiral downwards as Keyenes expounds on ideas first proposed by Irving Fisher which really are just echoes of antiquated mercantilist thinking.
What I contend is not to deny that wages move slower than the prices of consumer goods, but if anything this should be a reason to want deflation not inflation. First let's look at the structure of production to explore why wages would move slower in either direction.
Let's say my structure of production looks like so...
Labor+Materials+Tools = Consumer Good
Deflation Scenario
So if the Demand for the consumer good increases I have three choices on where I can costs in this simplified scenario. For many reasons I may try to cut costs as much as possible in Materials and Tools since they are homogenous instead of giving up my trained skilled labor which is heterogenous. I may still have to ask my labor to take some level of a cut in pay but only after I exausted my ability to lower the other prices. So essentially I may have been able to cut my costs enough to get a drop in price in the good of 10% yet from cutting costs elsewhere only had to cut labor costs by 5%.
So if this is going on across the economy essentially laborers will have gotten an effective pay raise cause goods have dropped in price more than their wages did. Given if you look at editorials in times like 1870's or late 1830's when you had this sort deflation without massive unemployment (actual growth in the 1870's) going on, yet psycoligically many people felt things were bad cause they saw the nominal numbers going down so there is something to be said for the psycological state of people.
Inflation Scenario
So let's say the demand for my goods has increased cause the money supply has grown for whatever reasons. Since demand is increasing all over the economy, the demand for the same materials and tools I use will increase over different industries and firms that use those same tools. This widespread demand increase will cause an increase in the price of my materials and tools which I'll have to pass on to the consumer yet this increase will be larger than any raise I may give to my laborers in a attempt to prevent too much of an increase in the final goods price that would effect it's demand.
So basically due to increases in costs primarily in capital goods the price of the good has gone up 10% and wages went up 5% which if this is a widepread phenomena results a pay cut for the laborer. Again, psycologically they feel good cause they see their nominal wages going up without realizing their real wages are going down. This is essentially the story in any bubble or boom, except due to problems with CPI calculations inflation is usually understated.
Conclusion
If sticky wages are a real phenomena then deflation would be the much better environment for real wages and for the laborer. Although what is usally proposed by Keynesians and other types of leftist is to push for more inflation which actually hurts real wages yet psycologically breeds consent of the labor class since they only think in nominal terms. In order to have the benefits of deflation yet without the psycological pessimism, it would be a proper use of an economic figurehead such as a president to explain this phenomena to manage expectations and sentiment.
by Alex Merced
The next few posts I'll be writing will be a series on some aspects of labor economics which will mainly center around wages and upward mobility. In this initial part of the series I'm going to address one of the main Keynesian buzzwords, "Sticky Wages".
John Maynard Keyes (read "Where Keynes went Wrong") makes the admission that it's plausible that an economy can self correct by allowing all prices to adjust downwards if the money supply is reduced for whatever reasons, but contends that there is a problem cause wages are "sticky" so this would make it difficult for businesses to adjust their inventories and prices to maintain the current labor supply since wages won't fall in line with everything else so unemployment ensues. This unemployment will then cause further contraction of the monetary supply causing the economy to just spiral downwards as Keyenes expounds on ideas first proposed by Irving Fisher which really are just echoes of antiquated mercantilist thinking.
What I contend is not to deny that wages move slower than the prices of consumer goods, but if anything this should be a reason to want deflation not inflation. First let's look at the structure of production to explore why wages would move slower in either direction.
Let's say my structure of production looks like so...
Labor+Materials+Tools = Consumer Good
Deflation Scenario
So if the Demand for the consumer good increases I have three choices on where I can costs in this simplified scenario. For many reasons I may try to cut costs as much as possible in Materials and Tools since they are homogenous instead of giving up my trained skilled labor which is heterogenous. I may still have to ask my labor to take some level of a cut in pay but only after I exausted my ability to lower the other prices. So essentially I may have been able to cut my costs enough to get a drop in price in the good of 10% yet from cutting costs elsewhere only had to cut labor costs by 5%.
So if this is going on across the economy essentially laborers will have gotten an effective pay raise cause goods have dropped in price more than their wages did. Given if you look at editorials in times like 1870's or late 1830's when you had this sort deflation without massive unemployment (actual growth in the 1870's) going on, yet psycoligically many people felt things were bad cause they saw the nominal numbers going down so there is something to be said for the psycological state of people.
Inflation Scenario
So let's say the demand for my goods has increased cause the money supply has grown for whatever reasons. Since demand is increasing all over the economy, the demand for the same materials and tools I use will increase over different industries and firms that use those same tools. This widespread demand increase will cause an increase in the price of my materials and tools which I'll have to pass on to the consumer yet this increase will be larger than any raise I may give to my laborers in a attempt to prevent too much of an increase in the final goods price that would effect it's demand.
So basically due to increases in costs primarily in capital goods the price of the good has gone up 10% and wages went up 5% which if this is a widepread phenomena results a pay cut for the laborer. Again, psycologically they feel good cause they see their nominal wages going up without realizing their real wages are going down. This is essentially the story in any bubble or boom, except due to problems with CPI calculations inflation is usually understated.
Conclusion
If sticky wages are a real phenomena then deflation would be the much better environment for real wages and for the laborer. Although what is usally proposed by Keynesians and other types of leftist is to push for more inflation which actually hurts real wages yet psycologically breeds consent of the labor class since they only think in nominal terms. In order to have the benefits of deflation yet without the psycological pessimism, it would be a proper use of an economic figurehead such as a president to explain this phenomena to manage expectations and sentiment.
Saturday, July 17, 2010
The Difference Between Inflation and Increasing Price Levels
The Difference Between Inflation and Increasing Price Levels
by Alex Merced
One of the biggest debates right now is the inflation versus deflation debate, and much of this debate hinges on the events in consumer goods prices, but can inflation occur even if prices drop? Can prices go up even if inflation hasn't occurred? Yes, and to understand this you need to have a proper definition of inflation As your baseline.
Inflation - Inflation is an increase in the money supply, not the mere act of rising price levels. The Money supply can increase and prices react in all sorts of ways across different sectors of the economy, no matter how they react the fundamental relationship between the demand for goods and the supply of money has changed and it will have it's effects on the economy.
Hyperinflation - Hyperinflation has more nuanced definition, it's not just merely that prices are increasing at super speeds, but that the faith in the money as a medium of exchange has broken. A good money requires people to believe that if they accept it that they can in turn use to trade with someone else, cause the seller usually has no interest in the money itself other than for trading. Although if the supply of money is expected to grow at large rates for the foreseeable future less people will accept the money due to the fear of the loss of purchasing power from the growing supply. If people have believe that the money in itself is stable measure of value they have no reason to stop using no matter what happens to prices due to innovation gains or natural increases in demands.
Cause of Hyperinflation in a Fiat World - So in a sense hyperinflation occurs when people lose faith in the money, not when prices are allowed to merely rise. In todays Fiat money world, if a governments budget gets larger than it's tax base it must participate in deficit spending. If the government can borrow domestically or from other countries the effect on the supply of money is minimal, but if it cannot find the demand for it's debt from willing lenders then it's central bank will create the demand by increasing the money supply, although this punishes the original domestic and foreign lenders by giving their investment purchasing power risk.
Because of this risk, those lenders in future financing will decide to lend less if not at all meaning the central bank will have to further increase the money supply at even larger quantities. Once a governments budget gets to the point that the only way of financing is through these liquidity injections with no end in sight, less people will begin willing to sell their foreign currency for the domestic currency, meaning foreign goods will begin rise in price dramatically. So as the world begins to lose faith in the domestic currency, the amount of the currency needed to exchange for goods cause of the wavering faith in the currency will see it's hyper inflationary crash. Thus it's crisis of faith in a currency, not a crisis in consumer good prices.
Price Increase and Decreases - While increased in the money supply (inflation) will have upward pressure on prices and a decrease in the money supply (deflation) prices can still go down and up in either environment for a variety of different reasons. Prices of technology go down in an inflationary environment cause of innovation in technology allowing to make the same good at lower prices, although inflation can erase much the nominal drop in price. Another you may see a drop in prices is a drop in demand which may be for a variety of reasons such as better alternatives, credit crunches, and more. Prices can increase in a deflationary environment cause demand for new goods is large, or special programs make credit available for certain goods such as housing or college tuition. Although all these price and increases/decreases would affect the consumer price index (CPI) although they have no fundamental bearing on weather the money itself is a stable medium of exchange. So essentially programs like fannie, freddie, and sallie may help create price bubbles it's really the money supply increases from the central bank that will lead to the destruction of the currency.
So how do I assess todays environment? - Well take the true monetary definition of inflation/deflation one must ask which one are we in? It really depend on which measure of the money supply you use, if you use the numbers like M1,M2, M3 which go beyond the base bank reserves and measure the circulating credit then it would appear as we've been spinning towards deflation. Since there's less credit available there is essentially less money available meaning demand will be limited causing price drops which clearly have been seen in goods such as clothing and other luxuries, although this doesn't really paint a picture of what's going on when the government finances it's budget.
If you take a look at the monetary base (bank reserves/dollars), this number has exploded has doubled and tripled at certain points. When the central bank injects liquidity to help finance the governments budget, the entry point is the monetary base and while credit hasn't been created on top of this base yet, it's still a sign to lenders of the future risk of their investments in US Treasuries (government debt). With many of the politically difficult to remove expenditures of the government budget, deficits seem to be perpetual and the amount of willing lenders has decreased to the point where the central bank is the largest holder of that debt. So while you may not see runaway prices increases you are seeing the faith in the dollar as stable medium of exchange eroding with only the fact that it's the reserve currency of the world, which is something that will take some time for the rest of the world to divest from, but it won't take forever.
Bottom Line: While credit contraction will have downward pressure on consumer prices, the increasing monetary base in order finance a growing government deficit will erode the faith in the currency to cause the inevitable hyperinflation.
by Alex Merced
One of the biggest debates right now is the inflation versus deflation debate, and much of this debate hinges on the events in consumer goods prices, but can inflation occur even if prices drop? Can prices go up even if inflation hasn't occurred? Yes, and to understand this you need to have a proper definition of inflation As your baseline.
Inflation - Inflation is an increase in the money supply, not the mere act of rising price levels. The Money supply can increase and prices react in all sorts of ways across different sectors of the economy, no matter how they react the fundamental relationship between the demand for goods and the supply of money has changed and it will have it's effects on the economy.
Hyperinflation - Hyperinflation has more nuanced definition, it's not just merely that prices are increasing at super speeds, but that the faith in the money as a medium of exchange has broken. A good money requires people to believe that if they accept it that they can in turn use to trade with someone else, cause the seller usually has no interest in the money itself other than for trading. Although if the supply of money is expected to grow at large rates for the foreseeable future less people will accept the money due to the fear of the loss of purchasing power from the growing supply. If people have believe that the money in itself is stable measure of value they have no reason to stop using no matter what happens to prices due to innovation gains or natural increases in demands.
Cause of Hyperinflation in a Fiat World - So in a sense hyperinflation occurs when people lose faith in the money, not when prices are allowed to merely rise. In todays Fiat money world, if a governments budget gets larger than it's tax base it must participate in deficit spending. If the government can borrow domestically or from other countries the effect on the supply of money is minimal, but if it cannot find the demand for it's debt from willing lenders then it's central bank will create the demand by increasing the money supply, although this punishes the original domestic and foreign lenders by giving their investment purchasing power risk.
Because of this risk, those lenders in future financing will decide to lend less if not at all meaning the central bank will have to further increase the money supply at even larger quantities. Once a governments budget gets to the point that the only way of financing is through these liquidity injections with no end in sight, less people will begin willing to sell their foreign currency for the domestic currency, meaning foreign goods will begin rise in price dramatically. So as the world begins to lose faith in the domestic currency, the amount of the currency needed to exchange for goods cause of the wavering faith in the currency will see it's hyper inflationary crash. Thus it's crisis of faith in a currency, not a crisis in consumer good prices.
Price Increase and Decreases - While increased in the money supply (inflation) will have upward pressure on prices and a decrease in the money supply (deflation) prices can still go down and up in either environment for a variety of different reasons. Prices of technology go down in an inflationary environment cause of innovation in technology allowing to make the same good at lower prices, although inflation can erase much the nominal drop in price. Another you may see a drop in prices is a drop in demand which may be for a variety of reasons such as better alternatives, credit crunches, and more. Prices can increase in a deflationary environment cause demand for new goods is large, or special programs make credit available for certain goods such as housing or college tuition. Although all these price and increases/decreases would affect the consumer price index (CPI) although they have no fundamental bearing on weather the money itself is a stable medium of exchange. So essentially programs like fannie, freddie, and sallie may help create price bubbles it's really the money supply increases from the central bank that will lead to the destruction of the currency.
So how do I assess todays environment? - Well take the true monetary definition of inflation/deflation one must ask which one are we in? It really depend on which measure of the money supply you use, if you use the numbers like M1,M2, M3 which go beyond the base bank reserves and measure the circulating credit then it would appear as we've been spinning towards deflation. Since there's less credit available there is essentially less money available meaning demand will be limited causing price drops which clearly have been seen in goods such as clothing and other luxuries, although this doesn't really paint a picture of what's going on when the government finances it's budget.
If you take a look at the monetary base (bank reserves/dollars), this number has exploded has doubled and tripled at certain points. When the central bank injects liquidity to help finance the governments budget, the entry point is the monetary base and while credit hasn't been created on top of this base yet, it's still a sign to lenders of the future risk of their investments in US Treasuries (government debt). With many of the politically difficult to remove expenditures of the government budget, deficits seem to be perpetual and the amount of willing lenders has decreased to the point where the central bank is the largest holder of that debt. So while you may not see runaway prices increases you are seeing the faith in the dollar as stable medium of exchange eroding with only the fact that it's the reserve currency of the world, which is something that will take some time for the rest of the world to divest from, but it won't take forever.
Bottom Line: While credit contraction will have downward pressure on consumer prices, the increasing monetary base in order finance a growing government deficit will erode the faith in the currency to cause the inevitable hyperinflation.
Wednesday, June 16, 2010
Tuesday, April 27, 2010
Wednesday, April 7, 2010
Is Deflation Better?
I constantly speak about the dangers of inflation (increase in the money supply), and inflationary pressures of a growing government. Inflation destroys our purchasing power, causes malinvestment, and encourages risker investing. Inflation is primarily on my mind cause it's more imminent, government is naturally incentivised to inflate, so inflation and it's danger are practical concern although some take this to mean deflation (a decrease in the money supply) is the desired alternative.
They paint this utopian image that in a world of deflation that purchasing power increases, savings will increase meaning more capital for investment and it'll breed a more prudent and moral society. In reality, deflation or any manipulation of the money supply will cause distortions in the economic calculation of market participants, just in different ways.
With deflation artificially increasing the value of money, and what is the story whenever we artificially the price of any good? When prices are fixed above the market price less people will be willing to consume that good so you end up with a surplus. This would be the result of a deflationary environment that even though savings will be available for lending for projects, lenders will not want to pay the higher price of money and will choose not to lend it. So now you have underutilization of resources, and while I would prefer under spending than over spending this is still not ideal.
So does this mean a constant money supply is wanted, not neccessarily because of the downward price level adjustments that will constantly occur to a fixed supply. The only solution to the money supply issue is have a supply free from human influence, meaning no FIAT or paper money. In a world with a commodity backed money, the supply will fluctuate based the demand for the money for industrial use and new money mined through labor.
It's in this world, absent from taxation, regulation, and FIAT money can individuals begin to more accuratly begin economic calculation.
They paint this utopian image that in a world of deflation that purchasing power increases, savings will increase meaning more capital for investment and it'll breed a more prudent and moral society. In reality, deflation or any manipulation of the money supply will cause distortions in the economic calculation of market participants, just in different ways.
With deflation artificially increasing the value of money, and what is the story whenever we artificially the price of any good? When prices are fixed above the market price less people will be willing to consume that good so you end up with a surplus. This would be the result of a deflationary environment that even though savings will be available for lending for projects, lenders will not want to pay the higher price of money and will choose not to lend it. So now you have underutilization of resources, and while I would prefer under spending than over spending this is still not ideal.
So does this mean a constant money supply is wanted, not neccessarily because of the downward price level adjustments that will constantly occur to a fixed supply. The only solution to the money supply issue is have a supply free from human influence, meaning no FIAT or paper money. In a world with a commodity backed money, the supply will fluctuate based the demand for the money for industrial use and new money mined through labor.
It's in this world, absent from taxation, regulation, and FIAT money can individuals begin to more accuratly begin economic calculation.
Tuesday, April 6, 2010
Treasuries, Investment, Interest Rates, and Risk
Treasuries, Investment, Interest Rates, and Risk
by Alex Merced
In todays world investment revolves around US Treasury debt cause it's AAA rating. Since the return yielded from treasuries is considered the "risk free" rate of return it establishes the minimum return someone should make from their investments. So since this interest plays sucha pivotal role in the investment decision and risk taking learning a little bit about how it works would be pretty important to understanding excessive risk taking by the banking system.
What is Treasury Debt?
We believe that it's taxes that pay for military, medicare, and all the other government services and programs we may approve or dissaprove of. In Reality, tax revenues are not enough to pay for the growing role of government and the public sector so money must be borrowed via bonds known as treasuries. As any debtor would, the government wants to pay the lowest rate possible so they have an auction for the debt similar to lendingtree in which the largest banks in the world known as primary dealers (for Primary Dealers include Lehman, Bear Sterns, Merrill, etc.) bid on the debt in order for debtor to get the lowest interest rate possible.
What is with all the demand for treasuries?
Now why would banks bid treasuries to near below inflation/CPI levels when they could use that capital for other higher yielding investments? In order for this to be the case there must be some mechanism to stimulate the demand of these banks very similar to what happened in the housing crisis...
Why did lenders make so many bad mortgages, cause they didn't have to hold the loans they could just turn around and sell it to Fannie or Freddie so this created artificial demand for mortgage debt pushing lending rates low. A similar mechanism is used with treasuries since these treasuries can be used in a variety of ways in dealing with the central bank, the federal reserve.
The central banks primary role in this is to keep fueling the demand for treasuries by entering in repurchasing agreements with these primary dealers. In these agreement the central bank promises to buy back these treasuries and to do so the central bank must expand the money supply (inflation). Also, these primary dealers can use these treasuries as collateral for loans from the discount window in order to get emergency funds when these banks overlend or practice bad banking. Essentially, in exchange for facilitating the financing of government operations the banking system are given their own life support system in the form of the federal reserve bank.
So as government increases it's deficits need the demand of treasuries to increase meaning more pressure on the federal reserve to buy these treasuries from the bank with new money (aka monetizing the debt). So as the federal reserve inflates the money supply to facilitate government spending the increase reserves of these bank effectivly lowers lending rates sending a flase signal to the economy of non-existant savings causing the mal-investment charachterized in the austrian theory of the business cycle.
The effects of all this on investment and risk taking
At the same time, this inflation of the money supply will put upward pressure on price levels which increases the neccessary return from investment needed to maintain purchasing power. Also the increasing government debt puts upward pressure on taxes which means even more must be yielded from investment to make up for the tax burden. So effectively, when you combine the burden of inflation and taxes the return needed to make any profit is so high that modest medium risk investing just doesn't yield enough putting pressure on investors and investment institutions to have to take on risker investments to just walk away with anything at all.
Moral of the story:
- Inflation and Taxation only stimulates risk taking and distorts economic calculation of investors
- Inflation and Taxation are a product of growing government spending
- In order to maintain this Government Spending a strong relationship between Government and Banking must be established
- To be truly against bank bailouts and for main street you must be against the central bank and runaway spending which creates the moral hazard that strips the nation of their savings and retirement
- To believe in government entitlement programs you must be for the bank bailouts, cause without the bailout government cannot continue it's funding of programs like medicare and social security
- Money lent to the growing public sector is money not lent to the private sector, so as one grows the other must shrink along with the countries productive capacity increasing the burden over time as more and more people find themselves pushed out of an economy that can support less and less people everyday.
by Alex Merced
In todays world investment revolves around US Treasury debt cause it's AAA rating. Since the return yielded from treasuries is considered the "risk free" rate of return it establishes the minimum return someone should make from their investments. So since this interest plays sucha pivotal role in the investment decision and risk taking learning a little bit about how it works would be pretty important to understanding excessive risk taking by the banking system.
What is Treasury Debt?
We believe that it's taxes that pay for military, medicare, and all the other government services and programs we may approve or dissaprove of. In Reality, tax revenues are not enough to pay for the growing role of government and the public sector so money must be borrowed via bonds known as treasuries. As any debtor would, the government wants to pay the lowest rate possible so they have an auction for the debt similar to lendingtree in which the largest banks in the world known as primary dealers (for Primary Dealers include Lehman, Bear Sterns, Merrill, etc.) bid on the debt in order for debtor to get the lowest interest rate possible.
What is with all the demand for treasuries?
Now why would banks bid treasuries to near below inflation/CPI levels when they could use that capital for other higher yielding investments? In order for this to be the case there must be some mechanism to stimulate the demand of these banks very similar to what happened in the housing crisis...
Why did lenders make so many bad mortgages, cause they didn't have to hold the loans they could just turn around and sell it to Fannie or Freddie so this created artificial demand for mortgage debt pushing lending rates low. A similar mechanism is used with treasuries since these treasuries can be used in a variety of ways in dealing with the central bank, the federal reserve.
The central banks primary role in this is to keep fueling the demand for treasuries by entering in repurchasing agreements with these primary dealers. In these agreement the central bank promises to buy back these treasuries and to do so the central bank must expand the money supply (inflation). Also, these primary dealers can use these treasuries as collateral for loans from the discount window in order to get emergency funds when these banks overlend or practice bad banking. Essentially, in exchange for facilitating the financing of government operations the banking system are given their own life support system in the form of the federal reserve bank.
So as government increases it's deficits need the demand of treasuries to increase meaning more pressure on the federal reserve to buy these treasuries from the bank with new money (aka monetizing the debt). So as the federal reserve inflates the money supply to facilitate government spending the increase reserves of these bank effectivly lowers lending rates sending a flase signal to the economy of non-existant savings causing the mal-investment charachterized in the austrian theory of the business cycle.
The effects of all this on investment and risk taking
At the same time, this inflation of the money supply will put upward pressure on price levels which increases the neccessary return from investment needed to maintain purchasing power. Also the increasing government debt puts upward pressure on taxes which means even more must be yielded from investment to make up for the tax burden. So effectively, when you combine the burden of inflation and taxes the return needed to make any profit is so high that modest medium risk investing just doesn't yield enough putting pressure on investors and investment institutions to have to take on risker investments to just walk away with anything at all.
Moral of the story:
- Inflation and Taxation only stimulates risk taking and distorts economic calculation of investors
- Inflation and Taxation are a product of growing government spending
- In order to maintain this Government Spending a strong relationship between Government and Banking must be established
- To be truly against bank bailouts and for main street you must be against the central bank and runaway spending which creates the moral hazard that strips the nation of their savings and retirement
- To believe in government entitlement programs you must be for the bank bailouts, cause without the bailout government cannot continue it's funding of programs like medicare and social security
- Money lent to the growing public sector is money not lent to the private sector, so as one grows the other must shrink along with the countries productive capacity increasing the burden over time as more and more people find themselves pushed out of an economy that can support less and less people everyday.
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