Re: where is the money coming from?

pyotr filipivich wrote:
[Default] I missed the Staff Meeting but the Minutes record that
Redbourn <redbourn@xxxxxxxxx> reported Elvis on Mon, 8 Dec 2008
10:28:43 -0800 (PST) in misc.survivalism :
Hi,

I know very little about the economy on a national or international
level which will be obvious from my question.

We read all the time about the huge amounts of money that governments
are 'pumping' into economies but I haven't read one article in which a
journalist mentions where it's coming from.

I just read the following in "Real Clear Politics"

"All this is a vast and daring monetary experiment, global in scope
and fraught with hazards. The new money and credit issued by the Fed
are created out of thin air. If the Fed is too timid, it may deepen
today's slump; the financial magazine Barron's -- hardly a socialist
bastion -- suggested the Fed should balloon its credit to an
astounding $6 trillion. But too much money and credit might someday
boomerang as higher inflation. Considering the consequences of being
wrong, Bernanke faces an enormous intellectual challenge and no less
an agonizing personal burden".

I have vaguely imagined that that governments either print the money
which in this case would cause massive inflation or they borrow it,
like the US says to China, 'we need to borrow a trillion dollars how
much will you charge?".

So how does it actually work?

it starts with the fact that "money" is an abstraction. it is a
method of keeping track of accounts, and possibly even as a store of
value. Currency serves as a means to demonstrate that you have
served your fellowman.
The origin of currency is in the "bearer notes" of ancient
Sumeria. These were clay tables on which was inscribed "present to
the bearer X amount of Commodity" Usually livestock, grain or some
"thing".
Later, you got standardized tokens, usually of gold or silver (due
to their compactness, relative rarity, and durability). Then
eventually paper tokens were invented (by the Chinese,too). We're
back to the original clay table "Pay to the bearer X amount of
Commodity" only now it is usually gold or silver.
The problem with paper currency is that you can print more. This
is also known as fractional banking - there are more notes out there
than there is commodity in reserve. If all the banknotes get
presented, there isn't enough "hard cash". But nowadays, there is no
commodity behind the banknotes.
On the pother hand, the origins of bonds is traced often to the
Italian city-state wars. Rather than try to pay for the war in cash
though with increased taxes, loans were made, with offers of
repayment, plus interest, after the war. Nowadays we're paying for
the day today running of the government by the same method - these are
the Treasury Notes and Bonds. If you watched Popeye, you'll remember
Wimpy's catchphrase, "I will gladly pay you Tuesday, for a hamburger
today." The Feds (and states and municipalities) are in essence
saying "I will pay you Tuesday for a dollar today." Or more
precisely "As I will gladly pay you ten bucks Monday, how much can you
loan me today?" Well, that all depends on how good you figure they are
for the debt. Sometimes, you'll offer 9.95 for that ten dollar bill,
sometimes you'll offer 9.75.
On a side note, but still important; The secondary markets is
where people who have bought those bonds (or stock certificates) are
selling their holdings. Both the seller and buyer consider that they
are making a smart move, and the price is set by both in consideration
of past history and future expectations. Or gut feelings, and the
phase of the moon. Who knows.

Anyway, what is currently happening, is that clever people are
creating "new" securities. Securities are so called because they are
"secured" by something. This is not new. Pawnshops have been
loaning money, secured by whatever it is that you have placed "in
pawn." If you do not pay back the loan, they can sell your security.
A house mortgage is "secured" by the value of the house. When you buy
stock on "margin", you put so much down and borrow the rest of the
price of a stock transaction, with the value of the stock serving as
collateral for the loan. Naturally, when the stock declines in price,
it maybe less than the value of the loan, in which case you get a
"margin call." You have to make up the difference between what you
borrowed and the value of the stock, or the broker will sell the stock
in an attempt to get his money back. (It is all allowed in the fine
print).

But, we are not in a hard cash economy. The vast majority of
business is not based on actual cash, but on bookkeeping. Consider
that for a lot of people, they work at their job, at the end of the
pay period, personnel sends a credit by direct deposit to the bank,
they never see any cash. The bank makes a direct deposit for the
mortgage, the worker buys groceries with a debit card, they send a
check to pay bills, etc. There is no "cash" in their lives.
And what goes for people, goes for institutions - including
governments. Your deduction for taxes is transferred to the IRS, then
into the Treasury accounts, and from there to the various government
agencies. And for example, some of it goes into a Food Stamps
account, which means that somewhere, somebody will use that card to
transfer "funds" from the Agriculture Department to the store, which
will go to someone's pay, from which taxes will be deducted,
electronically.. "Round and round we go."
Okay, back to the government. Because we have no hard cash basis
for the currency, we can create "money" by more bookkeeping. Usually,
what happens is that debt will be monetarize - that is to say more
debt is issued (bonds and notes) and those entries become the basis
for more entries which make more "credits" available to others. Yeah,
suddenly there is more "money" available. But when there is more
money than goods, prices rise - that is the essence of inflation. In
the spring of 1897, Dawson Creek, Yukon Territory, eggs were going for
$10 in gold. Because in Dawson Creek, there was lots of gold, but
very few eggs. Back in the 16th Century, because of the flood of
American silver and gold, prices in Spain began rising. Hey,
everybody (who counted) was rich, so it didn't matter. This goes to
demonstrate that inflation in a hard currency is possible, but a wee
bit more difficult. Oh yes, the Sultan of Timbuktu spent so much in
Cairo on his way to Mecca, that the price of gold was depressed for
ten years.

To attempt to get back to the original point, when the Government
needs money, and is unwilling to raise taxes, then it must borrow. But
here is the beauty of the modern economic model; the government can
sell debt (bonds) based on it's ability to pay (taxes or more
borrowing) and spend the money.
So the Federal Government is creating $700 Billion for the
bailout, by selling bonds to cover the debt. Remember, as long as the
books balance.
If you recall the original movie "We're No Angels" staring
Humphrey Bogart as a convicted embezzler. He and friends have escaped
from Prison and are planning to leave for France. But they get caught
up in the problems of the family in whose house they are hiding, which
includes the imminent arrival of the cousin to examine the books,
which are short 15,000 francs. Bogart offers to fix the problem. A
few entries here, a couple small adjustments there, and "violia!
15,000 francs." Scale it up and "violia $700 billion dollars."
created out of air. And everybody knows that there is nothing behind
this $700 billion (or any of the other trillions of dollars), so
prices get "adjusted" to account for the fact that there is now
another seven hundred billion bits of bookkeeping entries chasing the
same amount of real goods and services.
But if the government goes ahead and creates $6 trillion (six
thousand billion) in new bookkeeping entries, who will want more of
those entries? Or more properly, who will trust any of the other
entries?

Which means that yes, the Feds are going to go to the Chinese (and
everyone else) and repeatedly say "I will gladly sell you a hundred
dollar bill in ten years, how much will you bid for it now?" They
might do it for 700 billion, but for 6 000 billion?

Economics is as much psychological as it financial.

Excellent summary. The gold bugs won't like it, but there you are.

The alternative to inflation, Depression, is usually significantly worse, unfortunately. Inflation can get out of control (hyperinflation) when people do not trust the ability of the government to pay, and that is as bad as or worse than Depression (compare Weimar Germany to Depression U.S. in the 30s).

Dan
.

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