Replies

That is a good analogy for QE, as far as it goes.

However to simulate the real economy you have to go further. It isn’t just the Fed that (can) creates money out of thin air. In normal times, most new money creation is actually done by the banks by making oodles of “unfunded” loans through the “magic” of fractional reserves. That’s credit money.

These loans tend to inflate the value of assets - create bubbles. When a situation arises (such as now) where defaults on those loans start to snowball, then the value of most assets also crash.

At that point cash (currency) is king - it becomes way overvalued relative to the value of assets. (you can buy a house for $50K when it used to cost $200K)

At this point the banks are usually at or near insolvency, so they are in no position to make loans, and increase the amount of money in circulation.

The only entity that is capable of making loans is the Fed, through recapitalizing the banks by QE. So, given our current financial framework (fractional banking, fiat money, etc.) the Fed is actually doing the right thing. Without it’s intervention we would be in a much deeper depression. (Again, THAT’S GIVEN OUR CURRENT FINANCIAL FRAMEWORK. Whether or not this framework is good or bad, that’s a separate issue.) So I’m not that keen on piling on Bernanke - he’s got to deal with the framework he’s got, and given that, I don’t think he’s doing a bad job. I do believe though that once things have restabilized, it would be in our interest to revisit the whole framework (the Fed, fractional banking, gold, etc). But that takes political will - something in short supply.

What the fed has done, however has proven to not have worked too well. Most of the QE money that the banks got has ended up back in the Fed as excess reserves. In other words, the banks haven’t lent that money. (At one point I thought a better solution would have been to give the QE money directly to the people that had lost asset value (rather than the banks). But the moral hazard that would have created would have been immense.)

The question then is why aren’t the banks lending? I believe a key contributing factor has been that regulators have gone from one extreme to another. Whereas five or six years ago all you had to do is fog a mirror to get a loan, today you have to walk on water (although there’s been some relaxation lately). So even though you might have a ton of money to lend (and the banks actually do), the rules are such that few people or entities “qualify”.

I believe another factor holding down the demand for loans is the demonization of businesses and success by the Obama administration. Given their war on profits, hostile regulations by the thousands, and unending uncertainties, who in their right mind is going to risk his time and money in such a business climate?

So to make your poker game more like the real economy you have to add a few of these details.