Archive for Headline – Page 2

Robert Shiller: Don’t Invest in Housing

Robert Shiller of Yale was on Bloomberg yesterday discussing housing and his general outlook. But the most interesting comments were with regards to his general view of housing as it pertains to your overall portfolio. Shiller said that investing in housing was a “fad” and not a great historical investment. Of course, if you’re familiar with his long-term real returns chart  (see the chart in #9 here) housing generally generates returns that are in-line with inflation. US residential real estate just isn’t a great investment in real terms. Shiller explains why:

“Housing is traditionally is not viewed as a great investment. It takes maintenance, it depreciates, it goes out of style. All of those are problems. And there’s technical progress in housing. So, the new ones are better….So, why was it considered an investment? That was a fad. That was an idea that took hold in the early 2000’s. And I don’t expect it to come back. Not with the same force. So people might just decide, ‘yeah, I’ll diversify my portfolio. I’ll live in a rental.’ That is a very sensible thing for many people to do.

…From 1890 to 1990 the appreciation in US housing was just about zero.  That amazes people, but it shouldn’t be so amazing because the cost of construction and labor has been going down.

…They’re not really an investment vehicle unless you want it for your personal reasons.”

This is a contentious debate.  In strict economic terms housing is viewed as investment and not consumption.  That’s why the BLS doesn’t include house prices in the CPI.  Even though housing includes fixed investment, you’re really consuming your house over the course of many years so there’s elements of both consumption and investment in housing.  The reasoning Dr. Shiller uses here is a big part of the consumption.  A house is a depreciating asset even though the land might not be.

Obviously, there are a lot of moving parts here and I am not sure I completely agree with Dr. Shiller.  Well run rental properties and commercial properties can be good investments, but most of us are living in our homes.  We’re consuming our home one day at a time and hoping that the scarcity of housing and land will result in prices outperforming inflation.  But there’s a flaw in that thinking also.  Because housing is such a large portion of most people’s expenses it has a very close connection with wages which have a very close connection with inflation.  So it’s not surprising to see house prices revert to the mean when they diverge from the annual rate of inflation – in general, that’s a sign that prices aren’t supported by incomes.

Personally, I prefer to think of a house as a place that provides intangible benefits and not investment benefits.  You buy a house because it puts a roof over your head.  You buy a house to live in it, not to invest in it.  But, like commodities, housing has become its own “asset class” that Wall Street has packaged up and sold to the American public as an equivalent to buying 500 of the best companies in the world (the S&P 500).   Most people also don’t invest in the stock market, but that’s a different discussion….I wouldn’t go so far as to say that real estate can’t be a good investment for some people (mostly experts), but for most of us the odds are that “investing” in real estate is not the right way to think about things.

I’d love to hear reader thoughts on this topic….


Some Brief Thoughts on the CBO’s New Budget Projections

Understanding the importance of the Federal budget Deficit in recent years is really very simple.   In a healthy economic environment private investment is one of the primary drivers of economic growth and improvements in living standards.  But what happened in the Great Recession was highly unusual.  Private investment collapsed in an almost unprecedented fashion.  When GDP was contracting in the 2008/2009 period it was driven almost entirely by this collapse in gross private domestic investment.  So, getting the economy back on track was largely about replacing or healing this decline in the private sector driver of growth.

How was that done?  Simple, the government ran huge budget deficits.  So, spending as a percentage of GDP surged.  Government consumption expenditures surged in the same period as private investment collapsed.  As you can see, government expenditures have remained high though they’re trending down.  This has kept the economy moderately strong as the private sector healed.  But, as we can see above, private investment is still far below its historical average and below levels seen during any past recession.

At the end of the day, the economy is just a series of flows.  Consumers spend, businesses invest, government spends, all of this generates income, revenues, cash flows, and as long as the flow is steady and strong the economy expands and life appears all fine and dandy.  But when private investment collapsed the flow was weakened substantially.  Had we not kicked in the government spending to turn the flow back on we likely would have experienced an economic environment that would have resembled something closer to Spain or Greece as opposed to this muddle through we’re currently experiencing.

This is, in essence, the core to understanding the balance sheet recession theory (in addition to understanding WHY private investment collapsed the way it did – due to the debt bubble).  It’s not terribly complex.  So, you can understand why I am at least moderately concerned by the CBO’s latest projections:

“The federal budget deficit, which shrank as a percentage of GDP for the third year in a row in 2012, will fall again in 2013, if current laws remain the same. At an estimated $845 billion, the 2013 imbalance would be the first deficit in five years below $1 trillion; and at 5.3 percent of GDP, it would be only about half as large, relative to the size of the economy, as the deficit was in 2009. Nevertheless, if the laws that govern taxes and spending do not change, federal debt held by the public will reach 76 percent of GDP by the end of this fiscal year, the largest percentage since 1950.

With revenues expected to rise more rapidly than spending in the next few years under current law, the deficit is projected to dip as low as 2.4 percent of GDP by 2015. In later years, however, projected deficits rise steadily, reaching almost 4 percent of GDP in 2023. For the 2014–2023 period, deficits in CBO’s baseline projections total $7.0 trillion. With such deficits, federal debt would remain above 73 percent of GDP—far higher than the 39 percent average seen over the past four decades. (As recently as the end of 2007, federal debt equaled just 36 percent of GDP.) Moreover, debt would be increasing relative to the size of the economy in the second half of the decade.”

In order to get back to the normalcy of the pre-GFC days we need to see that first chart above get back to its historical average of about 0.16.  That’s a lot to ask given the time its taken just to improve back to current levels.

I’ve stated in the past that I though the balance sheet recession would end by 2013/2014.  And while debt trends have definitely improved we’re still seeing a very tepid private investment environment.  We could definitely see further improvement there, but I still think the downside in the deficit is the largest risk to economy at present.  I’ve probably been a bit overly optimistic about the improvement in the balance sheet recession as I see private investment remaining weak well into 2014.  And that means the private sector will need continued help as it heals.

Back in the Saddle….

Sorry for the slowdown at the site.  I got interrupted by the rare vacation.  Things will be back to normal once I decompress and wake up to the reality that is “work”.  But first, some travel thoughts:

  • Asia is an incredible place.  It was my first time there and I can’t say enough good things about it.
  • Chinese immigration and customs are a nightmare.  If you think the TSA is bad you’ve never seen a Chinese bag checker scan every piece of electronics you have – 1 by 1 multiple times.  You want thorough – these are your guys.
  • The Thais could possibly be the nicest people on the planet.  If you’ve never been to Thailand you’re missing out on one of the most beautiful places on earth and some of the most friendly people on the planet.   If I could begin to comprehend the language I wouldn’t have ever come back.
  • After a nightmare ordeal with Chinese airlines and immigration I couldn’t have been happier to see a US customs and immigration agent.  Then he started berating me like I was from Mars and I quickly realized how much I missed the Thai customs and immigration agents.  The berating for non-residents looked 10X worse.
  • It’s amazing to see the undeveloped portions of some nations in Asia.  Americans complain about how bad things are, but the standard of living is comparatively off the charts in so many ways.   I hate to downplay our problems, but many of the developed nations have so much to be thankful for.
  • As I complained about my flights I was constantly trying to keep things in perspective.  I was flying around the world in metal tubes at 500 MPH and staying in hotels in amazing parts of the world.  If you’re reading this you’ve likely experienced the same things that appear all too “normal” for many of us, but are in fact extraordinary normalcies compared to what much of the world has access to.  Odds are, if you spend your time worrying about the concerns expressed on this website you’re in a pretty good place to begin with.  I for one am extremely thankful and try to keep that in perspective.  It’s nice to get out of the US “bubble” every once in a while to help reinforce the point.
  • The mostly cash/coin centric undeveloped countries had my monetary mind constantly asking my fellow travellers annoying monetary theory questions.  As I see the developed countries moving towards electronic money economies I couldn’t help but think that the paper bugs are simply the next monetary evolution from hard money bugs.  And just as quickly going extinct….I guess you can call me an electronic money bug.  Money is fast moving away from being a “thing” and more towards a mere record of account.

My brain is fried.  I’ll be fully operational by some point this week.  And by “fully operational” I mean that I hope to have all 75 IQ points firing on all cylinders.


Weekend Reading: There’s More to Life than Happiness

A big part of my work has been influenced by the French philosopher Volney who stated that human beings strive to become happy through becoming better and more virtuous. In Empire of Ruins he wrote that the purpose of life was:

“To render you more happy…by rendering you better and more virtuous. It is to teach man to enjoy his benefits, and not injure his fellows…”

In other words, happiness is not merely about making yourself happy. It is, in large part, about giving something to the world that makes the world a better place. That could be goods or services or your time or something else. Who knows? But happiness is not merely the pursuit of personal happiness, but providing something to your surroundings that gives other people reason to value your contribution. That’s the path to true wealth. We could go off on tangents here about what’s “productive” and what’s not, but the value of your contribution to society is ultimately determined by other people and the demand for your contribution (whatever it might be). So, the true path to wealth is giving something back. In essence, true happiness is derived from giving something more to others than you give to yourself.

Anyhow, I am blathering, but I was excited to read this story in The Atlantic from January about the same issues. Give it a read, give it some thought and tell me where I am wrong if you think so….



GDP Declines -0.1% in Q4

I am kind of out of the loop here due to travel so my apologies on such a brief post.  

As you likely know by now, Q4 GDP fell by -0.1%.  A decline in the rate was expected, but worse than analyst expectations of 1% growth.  The decline was primarily driven by declines in government spending and private investment.  We can get a bit more granular by focusing on the specific components by contribution.  Remember, GDP = C + I + G + (X-M) where C is personal consumption, I is private Investment, G is government expenditure and (X-M) is net exports.  The math here is pretty simple.  The quarterly the breakdown was as follows:

GDP = C + I + G  + (X-M)


-0.1% = 1.52% + -0.08% + -1.33% + -0.25% 

See figure 1 below for the visual breakdown.   Obviously, the big drag is due to the fastest pace of decline in defense spending (oart of the G component) in 40 years which dragged down the government component to -1.33%.  In a balance sheet recession, the government component is crucial as it helps provide the income that the de-leveraging consumer can spend while paying down debt.

All in all, the economy remains incredibly fragile.  The good news is that the deficit isn’t expected to decline to a large degree in 2013.  BUT, the debt ceiling debates linger and the risk is a large cuts that would drive this data deeper into the red and into a certain recessionary environment.  I don’t think the headline figure is worth panicking over, but it highlights the importance of the government component in this economic environment.  And it shows why the debt ceiling debates will likely steer the economy in 2013.

(Figure 1 – GDP by component contribution via Orcam Group)

On Using Technical Analysis

There’s been a broad discussion in recent weeks about the efficacy of technical analysis in investment strategy (see here & here).  I’ve touched on this briefly in the past (see here), but my position is rather simple and I think it’s a position most people should adopt, because, obviously, you should adopt my views of the world!  Just kidding of course.  You’re free to do with my thoughts as you wish and I am only here to provide one guy’s perspective and not pretend to offer some holy grail view of the world.

Anyhow, much of the confusion on this discussion starts with definitions. Technical analysis often gets a bad rap for being labelled as charting.  But they’re two different, but related things.  Charting is the use of chart reading in various ways to formulate strategies.  Technical analysis, on the other hand, is simply the use of past data to analyze future market direction.  Of course, a chart is merely a picture of past price action so charting is a subset of technical analysis, but does not comprise the universe of technical analysis – some of which can be extremely complex and sophisticated.

I find that understanding the past is an essential element in any good form of portfolio construction.  Perhaps you study the past to conclude that market timing is silly.  Or perhaps you study the past to conclude that buy and hold is silly.  But in the end, what most of us end up doing is essentially a branch of portfolio construction that begins with understanding past performance.  Of course, past performance is not indicative of future returns and while history rhymes, it rarely repeats perfectly.  So understanding past price performance and the history of price action is merely one building block in the development of a portfolio.  But that doesn’t mean it is a useless piece of the puzzle.  Whether you’re a trader or a buy and hold investor it’s useful to understand technical analysis and past price performance in order to better understand how one should go about attacking the future.

Of course, I am a very fundamentally driven analyst so I take the view that technical analysis is a good complement to good fundamental analysis, but to each his own.  In sum, keep an open mind.  There’s no holy grail to the world of portfolio construction and understanding and embedding many different approaches into your own will only make you a more well-rounded and informed investor/saver.

The Recession Calls Were Wrong

When I started this website I knew pretty quickly what would generate traffic and attention.  If you write about things that really scare people, conspiracy theories, Apple and gold you can drive enough traffic to a financial website to make a  decent living (until people realize you’re basically scamming them).  I told myself I’d choose quality over quantity and that I would TRY, above all else, to provide relevant, educational and ACCURATE information for people.  I knew it wouldn’t be enough to make the site sustain itself, but I truly felt that the alternative was a dishonest and low value way to write about finance, money and investing.  I don’t always succeed in this goal, but I always try.

One of the few things I’ve been right about is the “no recession” call since many notable investors and pundits began loudly declaring recession in late 2011.  I said none of the indicators were pointing to renewed recession and that the likelihood was for continued meager growth within the de-leveraging cycle.  In essence, misunderstanding the balance sheet recession was deadly for your portfolio and your general understanding of macro trends.

Now, I know I don’t make many friends writing happy things about the economy, but the bottom line is that the global economy could be much worse, policy makers could be wrecking the economy and American businesses could be far worse off than they are. We’re in this world where things are adequate enough to remain positive.  All things considered, that’s pretty positive since we’re coming out of the worst and most unusual economic crisis of the last 80 years.   This morning’s economic data was just further confirmation of this reality.   Here are three clear indications that the recession calls were completely wrong and are likely to remain wrong for the foreseeable future.

1.  Jobless claims are at a post-recession low:

2.  US PMI continues to show a clear expansionary trend:

3.  The Orcam Recession Index, which helps steer me to my main conclusion regarding growth, remains positive:


Keep Banks Out of Macro?

Scott Sumner says we should keep banks out of macro.  I Think that’s a very strange comment coming from a monetarist or even any economist.  Whether he knows it or not, monetary policy works primarily through the banking system via the Fed’s ability to influence interest rates.  When the economy is too hot the Fed increases the cost of overnight borrowing thereby reducing the spread at which banks make money in an attempt to tighten the supply of loans.  Of course, there’s no such thing as easing the supply of loans because the idea of a “supply of loans” is a confused concept since banks are only capital constrained in their ability to make new loans.  So, it’s not like they have a big supply of loans on shelves that are waiting to fly off them.  Healthy banks make loans when creditworthy customers walk in their doors.

Anyhow, getting back on track – the Fed has some control over money.  After all, it has monopoly power over the overnight rate.  But this is merely one piece of the money supply puzzle.  The real control of the money supply rests with borrowers demanding loans and the rate at which banks set those loans (of which the overnight rate is an important influence).  But the Fed is not the omnipotent entity that most presume.  And this cuts right to the core of the problem with Sumner’s statement – modern macroeconomists don’t really know what money is.  Nor do they seem to care.  If more macroeconomists understood that money is credit they’d care more about banking.

To me, banks are like the circulatory system in the human body.  They’re the primary means through which money (most of which is issued by banks in a modern monetary system) is issued and circulated.  When the banks aren’t working or consumers aren’t borrowing the system seizes up.  If the human body doesn’t have a consistent flow the body dies.  The major organs can’t operate otherwise.  An economy is no different.  Banks are not just a crucial piece of the entire monetary puzzle.  They are, arguably, the most important piece.  To claim that they should be kept out of macro is patently absurd.

The Continual Failure to Understand the Balance Sheet Recession

Ezra Klein and Bill McBride are excited that the government is reducing spending in the next years because he says it’s “real progress on the debt”.  He says:

“Let’s do some quick math. Start the clock — and the deficit projections — on Jan. 1, 2011. Congress cut expected spending by $585 billion during the 2011 appropriations process. It cut another $860 billion as part of the resolution to the 2011 debt-ceiling standoff. And it added another $1 trillion in spending cuts as part of the sequester. Then it raised $600 billion in taxes in the fiscal cliff deal.

Together, that’s slightly more than $3 trillion in deficit reduction. After accounting for reduced interest payments — as there’s now less debt to pay interest on — it’s more like $3.6 trillion. That’s real money!

In fact, that’s about enough to stabilize the nation’s debt-to-GDP ratio over the next decade. If over the next few years, say, there’s another $800 billion in deficit reduction — imagine a new deal that cuts $400 billion from Medicare and other mandatory spending while raising $400 billion in taxes — then the country is put on a declining debt path.”

 Of course, he’s not alone.  This has been a perpetual concern by policymakers and pundits for years running.  And it’s completely wrong.  The saddest part is that this isn’t terribly hard to understand.  The balance sheet recession is a rather simple concept.  We know from Wynne Godley’s sectoral balances that the sum of the private (private), foreign (x-m) and government (t-g) sectors must add up to zero.  In wonk talk, that’s:

(S-I) + (T-G) + (M-X) = 0

If we get a bit more granular we can really break this down to understand how the economy grows.  Monetary Realists like to use this breakdown:

S = I + (G – T) + (X – M)

Which rearranges to:

S = I + (S – I)

This takes the private sector component and breaks it down to shows a clear distinction between households and businesses by showing a focus on private investment.  In other words, the (S-I) piece grows primarily through two pieces – household consumption AND private investment.  But what happened in the last recession?  Private investment and domestic consumption fell in unprecedented ways.  And while both are crawling back we’re still digging out of a deep hole.  So that left two sectors to bring us out of the hole.  The foreign sector in the USA is a current account deficit so it’s a drag  on growth.  That leaves the government sector to drive spending.

The most interesting part about this entire recession is that we’re seeing two real-time experiments play out.  In Europe, where the problems were largely the same, many of the economies are in depression because the government sector pulled back spending at a time when the foreign and private sectors couldn’t sustain growth.  So you ended up with depressionary economic environments in many countries.  But in the USA you’ve seen continued (meager) growth.  Why?  Because the government continued to run a large budget deficit.  This isn’t to imply that deficits are always good and that government spending can’t ever go wrong, but this environment was literally “different this time”.

But still, we hear endlessly about how this deficit has been bad.  We hear about how the debt in the USA, a nation that can’t “run out of money” is somehow going to drive us to bankruptcy.  It’s all wrong.  Yet we still read about the same myths on a daily basis.  It would be funny if it wasn’t so sad.

All Your Dorks Are Belong to This

Paul Krugman has another post up about the difference between money and debt.  He raises a relevant question which starts to get to the heart of the real matter at hand:

“My concern is that when saying that money and debt are the same thing, it’s way too easy to lose sight of the real distinctions between monetary and fiscal policy that remain.”

If this were the movie Inception I’d be in the dream sequence one level deeper than Paul Krugman because I don’t quite think he’s asking the right question.  The real question is not about confusion over monetary policy and fiscal policy, but the NEXUS of monetary policy and fiscal policy.  In essence, does it matter whether a government self finances through direct deposit issuance or finances itself by selling bonds to the private sector?

As I explained previously, the design of our system is as such.  Paul buys a bond at auction which gives the government a bank deposit which allows them to spend the deposit into Peter’s account.  In short form, most government spending is bank deposit in (from Paul), bank deposit out (via government spending to Peter) PLUS net financial assets as bonds (to Paul).  If the government were to self finance it wouldn’t sell the bond.  It would just issue a net financial asset to Peter in the form of a bank deposit.  Spending is primarily based on the relationship between current income relative to desired saving so there shouldn’t be much of a difference in all of this on an inflationary front (though one could argue that bonds are slightly less liquid than cash, but I think we’re splitting hairs there).  Peter ends up with a deposit in either case and the private sector ends up with a net financial asset in either case.  No big deal, right?  Not quite.

Paul will still want to save in something that protects him from potential purchasing power loss of cash.  So he’ll go out and search for a financial asset to provide that savings/income need.  Now, the government could issue bonds to meet this need, but then we’re just sterilizing the deposit issuance and nothing is solved from the change in the system via direct deposit issuance.   This is basically what the government does now and it’s hugely supportive to the private equity structure of “rentier capitalism”.   If the government doesn’t issue the risk-free assets then we end up in an Izabella Kaminska world where there aren’t enough risk free assets and banks go crazy supplying the private sector with close (less stable) alternatives.  We all know how that ends up.   It’s inherently destabilizing.

So what this all really comes down to is rather simple.  It comes down to whether we want to have a private sector banking system and a government that supports that system.  Paul Krugman’s original question touches on this, but not quite in the right manner because the Fed, at the end of the day, is a public/private hybrid entity designed to support private banking.  The alternative to this system is to start tearing down the walls of the Fed and start taking a jackhammer to the foundation of private banking.  The government must choose to use the Fed and Treasury to support the capital structure of private banks or it must not support it and accept the destabilizing effects that will inevitably result in bailouts and government intervention.   You can’t have it both ways.

In sum, yes, we could theoretically self finance, but a lack of risk free asset issuance will simply result in a destabilizing banking system.  So we can self finance and issue the bonds, but then why bother changing the institutional structures from what they are today if this all ultimately ends up supporting the private equity structure of private banking in the end anyhow?  It’s not even worth the trouble.  On the other hand, the only way to self finance with direct deposit issuance without also creating an inherently fragile private banking system is to bring the banking system under the government umbrella in that dirty “N word” (no, not your favorite word, Quentin Tarantino).  But then a bunch of bureaucrats end up managing their own form of the shadow banking system….

I’m afraid the best we’re going to do in altering the current system is to better regulate the banks and better understand the actual structure of the monetary system we have.  The platinum coin created a great thought experiment for everyone and hopefully provided some important lessons and understandings about government spending and our monetary system, but this dream sequence is ending and it’s now time to wake up to the reality of our monetary system designed largely around the existence of private banking.  

*  For the real wonks, Scott Fullwiler has the only post up on all of this that displays a total understanding of the concepts at hand, but I’m not sure he’s deep enough in the dream sequence….

All Your Bases and Dead Presidents Are Belong to the Government?

A serious wonk debate has broken out over the trillion dollar coin and its ramifications.  As I said 18 months ago when I first discussed the coin here, this idea was never going to come to fruition, but it made for a seriously important discussion regarding our monetary system.  All roads lead to MR on this debate, whether through MR co-founder Carlos Mucha, who founded the coin idea or the inevitable debate over government self financing and JKH’s Contingent Institutional Approach).

Paul Krugman asks the question that all of this debate inevitably leads to:

“what happens if the US government issues a trillion-dollar coin to pay its bills?”

I would change the question slightly for the sake of simplicity.  Instead of a coin, what if the government used its powers as an autonomous currency issuer to just create bank deposits?

It might help to step back a second first before we jump in the mud here.   The monetary system we currently have does not operate as most people believe.  The government doesn’t “print money” (except in the literal case of cash notes and coins), but is actually the issuer of net financial assets.  So, when Peter uses his Treasury Direct account to buy a government t-bill he is divested of a bank deposit that ultimately allows the government to spend a bank deposit into Paul’s account.  Peter gets a US T-bill, no longer has a bank deposit and Paul ends up with  a bank deposit.  There is the same amount of bank deposits in the private sector, but there is an additional financial asset in the form of the bond.

But what if the government didn’t sell t-bills?  Instead of divesting Peter of a bank deposit (and giving him a NFA as t-bill) the government would just type a bank deposit into Paul’s account when Congress wants to spend.  So Peter still has his bank deposit AND Paul has a net financial asset in the form of a bank deposit.  The government, in this case, is a pure issuer of money.  If one were so inclined to call t-bills pure “money” you could claim that the first and second example are virtually the same (aside from the obvious politics involved).

The question this argument really gets at the heart of is the moneyness of government bonds versus bank deposits.  I have argued that t-bills have a very high level of moneyness.  That is, they are highly liquid and risk free, but not pure money.  For instance, if two men are standing in Wal-Mart, one holding $100 in cash (or a credit card) and the other holding $100 in physical t-bills they do not both have money in the eyes of Wal-Mart (the problem of money is not defining it, but convincing others to accept it).  Ie, they cannot both ring the register.  One must sell his t-bills to the other to obtain the cash for purchases.  Now, technology is reducing the discrepancy in “moneyness” between these assets, but the inconvenience of transferability still exists to some degree.  A bank deposit will always have a higher level of “moneyness” than a t-bill.   How this discrepancy influences inflation is up for debate.

But an equally important debate rages over the monetary base and Krugman’s “dead presidents” (cash).   Ultimately, the question in the above discussion leads to a debate over inflation, the degree to which the Fed maintains control of the money supply and the very design of our monetary system.  But first we should agree on a few things:

  • Money is almost entirely endogenous in our monetary system.  Ie, the money supply is determined by private banks who issue loans based on the demand by their clientele.
  • The money multiplier is not just broken.  It is non-existent.  Bank loans create deposits.  Banks find reserves after the fact if they must.
  • The central bank can influence the cost of supplying these loans, but has far less control over the demand for this money.
  • The terms “base money” and “high powered money” are unfortunate terms that should be done away with as they put the cart before the horse in terms of understanding the first three bullet points here.

If the bullet points didn’t help connect the dots already, we should all be realizing that the Fed has less control over the money supply than most of us have been led to believe.  The money supply being endogenously controlled by the banking system means that the Fed can influence the cost of money, but cannot completely control the supply of money.  The money supply is largely regulated by market conditions and the demand for loans.  In other words, the money supply is almost entirely privatized in the USA.  The Fed tries to influence the cost of this money by gauging economic conditions and forecasting policy changes to economic agents.

So, what happens to this system if the government self finances?  Obviously, we’re entering a monumental paradigm shift. We’re transferring from a system where money is created endogenously by banks who compete to issue money, to a system where the government exogenously creates money.   It’s almost impossible difficult to say whether one system is more inflationary than the other.  But what becomes clear in a system of government self financing is that the existence of private banking becomes increasingly less significant which would render the need for the central bank as increasingly less significant (since the central bank exists to support private banks and operates policy through the banking system).

The trillion dollar coin is not a debate about Fed influence, inflation and dead presidents.  It is a debate about a monumental paradigm shift in our monetary system.  A debate that shakes the core of modern banking and the monetary system we have designed around a  market based money issuing system where banks compete privately to issue money as debt.

Burn This Into Your Brain….

I really like this quote from the NY Fed:

“Most commonly used measures of the broad money supply include both currency and certain types of bank deposits, which in effect represent money created by banks when they make loans, but not reserves. These broad money measures tend to be more directly relevant for economic activity and inflation.” (emphasis added)

Almost everything we’ve all learned about money and economics is built around the government or its agents (primarily the Fed).  We are all taught through popular mythology that the government has a “printing press”, that the Fed creates all the money or that the government creates all the money.  Most economic models are designed around this thinking.  Monetarists build their theories around the idea that the Fed controls the money supply. Keynesians say the government can control the money supply through various countercyclical policies.  The quantity theory of money still dominates economic models.  And the money multiplier runs rampant implying some direct connection between banks and the government.  In essence, we always come back to one form of money that supposedly “rules the monetary roost” – high powered money or what MR would call “outside money” – money created by the government outside the private sector.

We’ve all been led to believe that this is the form of money that matters most because it is the form of money that is used in policy to steer the economy in some way.  This ties nicely into my recent commentary on economic ideology and how policy perversion results in policymakers and economists assuming that they can steer the economy and the money supply through their various “solutions” to problems.  The only problem is that this is all entirely backwards.

As the NY Fed states, the money that matters most does not come from outside the private sector.  It comes from inside the private sector.  Banks rule the monetary roost.  Government money is nothing but a facilitating feature.  It is a support structure designed to influence and support the use of bank issued money. We’ve all been lied to.

See the MR primer here for the way the system and its institutions are actually designed….

Social Constructs, Self Constraints & Monetary Myths

I really liked this piece by Paul Krugman on money in general.  Of particular importance is this paragraph:

“For people like me, on the other hand, the economy is a social system, created by and for people. Money is a social contrivance and convenience that makes this social system work better — and should be adjusted, both in quantity and in characteristics, whenever there is compelling evidence that this would lead to better outcomes. It often makes sense to put constraints on our actions, e.g. by pegging to another currency or granting the central bank a high degree of independence, but these are things done for operational convenience or to improve policy credibility, not moral commitments — and they are always up for reconsideration when circumstances change.”

Boy, that almost sounds like MR verbatim.  Money is most certainly a social construct.  It is something we create primarily for efficiency as a medium of exchange.  Money has other characteristics, but this is the root of the tool that is money.  The aspect of the monetary system as a “social system” requires some elaboration because I think it’s easy to confuse the balance of private sector and public sector.  The monetary system exists primarily to facilitate private sector exchanges.  It does not exist primarily to facilitate public exchanges.  Another way of saying this is that we leverage the strength of our private sector to move resources into the public sphere.  Resources precede taxation.  So the stronger the private sector the stronger the public sector can be.  As I like to say, government is designed to facilitate, not to lead.  Of course, this doesn’t mean government is bad or even mostly bad.  Not at all.  But like money, it is a tool that we create to achieve a certain social goal.  It can be abused, misunderstood and counterproductive.  But that is generally because its users allow it to be corrupted.  Not because government is an inherently evil institution.  Understanding this is all about maintaining a sense of balance.  Too often these discussions fall on deaf ears due to the extremist position taken by one side or the other.  That doesn’t help anyone better understand any of this.

I think Dr. Krugman’s comments on self imposed constraints are equally important.  The USA is a government and monetary system that is designed around checks and balances. No single entity has a monopoly on any sort of power.  One of the most confused notions in the USA is the fact that we have privatized money creation to private banks.  In other words, private corporations compete for the demand of loans in a market based money creation system.  Further, we have designed a Federal Reserve system that facilitates and supports this design primarily through an efficient payments system that brings interbank settlement into one market.  I’m no Fed apologist (I think their powers are at times abused), but I think it’s crucial to understand the institutional design of the Fed and its rather rational existence (as a support mechanism for a market based money system that is inherently unstable).

There’s a lot more to add to these points, but that’s a good starting point for discussion….As always, I highly recommend reading the MR recommended readings on these subjects as they provide, what I believe is the single best publicly available description of the monetary system that currently exists.  To me, this is about studying history, understanding our system and understanding why certain institutions exist the way they do.  It’s not entirely irrational though it’s also not perfect.   But it’s imperative that we better understand why we have what we have because there is a dangerous amount of mythology circulating about all of this resulting in deeply misguided policy responses….

Loeb Versus Ackman – Sharks Eating the Sharks….

If you’re not familiar with what’s going on with Herbalife stock these days you’re missing out.  I don’t generally pay too much attention to individual stock stuff, but this is shaping up to be one of the great modern investment battles.

In one corner, you’ve got Bill Ackman who runs Pershing Square Capital, a $11B fund that is involved in primarily activist investing. Ackman very publicly attacked Herbalife in recent weeks stating the company was a pyramid scheme and worth $0.  Yes, zero.  Ackman’s fund has reportedly taken a 9% stake in the company on the short side.

Enter Dan Loeb.  Loeb is the founder of  Third Point, a $10B fund specializing in…activist investing (among other strategies).  Loeb has reportedly taken a 8.2% position in the stock citing a $60 price target.  In other words, Loeb is essentially taking the other side of Ackman’s bet.

What’s so interesting about this battle is not only that these are two of the most high profile hedge fund managers in America, but that they both like to put on a show.  Loeb is well known for publicly lashing out at executives who don’t perform in-line with Loeb’s expectations.  Ackman is a bit less public, but put on quite the spectacle with the recent Herbalife presentation.

I have to admit that I think the public attack on Herbalife felt all wrong from the start.  Not that I think Ackman’s position is wrong.  I have no idea – micro is not my expertise.  Herbalife could be a pyramid scheme as he claims.  But I just didn’t like the very public assassination of the company and the big show that was put on.  It all appeared very odd.  Particularly when one considers the huge options trades that were made right before the presentations (which are now the subject of an SEC investigation).  It just felt all wrong to me.  The timing was odd, the presentation appeared intentionally malicious, etc.  It just felt like hedge funds contributing to society in a way that was largely void of value….That’s just my personal feeling around the whole thing.  I could be totally wrong.

But now we’ve got the sharks eating the sharks. We’re talking about one of the great investment battles that will ever play out in real-time.  Someone’s fund is going to take a huge hit due to this one position.  It’s extremely unusual to know who is shorting a stock.  It’s even more unusual to know that one high profile investor is directly taking the other side of the trade.  I don’t know who is going to be right.  But it will certainly be fun to watch.

Philip Diehl, Former Head of the US Mint Addresses Confusion Over the Platinum Coin Idea

Philip Diehl, former head of the US Mint and co-author of the platinum coin law comments on the recent confusion and discussions over the use of the platinum coin.  This is a must read:

I’m the former Mint director and Treasury chief of staff who, with Rep. Mike Castle, wrote the platinum coin law and produced the original coin authorized by the law. Therefore, I’m in a unique position to address some confusion I’ve seen in the media about the $1 trillion platinum coin proposal.

* In minting the $1 trillion platinum coin, the Treasury Secretary would be exercising authority which Congress has granted routinely for more than 220 years. The Secretary’s authority is derived from an Act of Congress (in fact, a GOP Congress) under power expressly granted to Congress in the Constitution (Article 1, Section 8).

* What is unusual about the law (Sec. 5112 of title 31, United States Code) is that it gives the Secretary complete discretion regarding all specifications of the coin, including denominations.

* Moreover, the accounting treatment of the coin is identical to the treatment of all other coins. The Mint strikes the coin, ships it to the Fed, books $1 trillion, and transfers $1 trillion to the treasury’s general fund where it is available to finance government operations just like with proceeds of bond sales or additional tax revenues. The same applies for a quarter dollar.

* Once the debt limit is raised, the Fed ships the coin back to the Mint, the accounting treatment is reversed, and the coin is melted. The coin would never be “issued” or circulated and bonds would not be needed to back the coin.

* There are no negative macroeconomic effects. This works just like additional tax revenue or borrowing under a higher debt limit. In fact, when the debt limit is raised, Treasury would sell more bonds, the $1 trillion dollars would be taken off the books, and the coin would be melted.

* This does not raise the debt limit so it can’t be characterized as circumventing congressional authority over the debt limit. Rather, it delays when the debt limit is reached.

* This preserves congressional authority over the debt limit in a way that reliance on the 14th Amendment would not. It also avoids the protracted court battles the 14th Amendment option would entail and avoids another confrontation with the Roberts Court.

* Any court challenge is likely to be quickly dismissed since (1) authority to mint the coin is firmly rooted in law that itself is grounded in the expressed constitutional powers of Congress, (2) Treasury has routinely exercised this authority since the birth of the republic, and (3) the accounting treatment of the coin is entirely routine.

* Yes, this is an unintended consequence of the platinum coin bill, but how many other pieces of legislation have had unintended consequences? Most, I’d guess.

Philip N. Diehl
35th Director
United States Mint