Posted on 09/14/2009 10:54:58 AM PDT by BGHater
Even a rather wobbly reserve currency is a better asset than gold, whose price again crossed the US$1,000 mark last week.Gold is far less liquid than US Treasury securities,costly to store and insure,and above all far more volatile in price.
Gold's price volatility since January 2000(the standard deviation of the daily price divided by the average) is 45%, almost triple that of the US dollar-euro exchange rate. In a functioning world financial system,in which investors trust governments to control extreme instability, even an indifferently managed reserve currency with a broad capital market behind it is better than gold.
Strictly speaking, gold isn't an investment but an insurance policy against a breakdown of the functioning of the world financial system. In particular, it represents insurance against the breakdown of the political understandings that make possible a world financial system. That is why gold reached its all-time peak (in inflation-adjusted) terms at the end of 1979, when the Soviet Union invaded Afghanistan.
Divided by the US Consumer Price Index (CPI), the price of gold trades at half its 1979 peak, when the world had cause to believe that America would lose the Cold War. American diplomats still were hostage to the Iranian Revolutionary Guards Corps in Tehran; a rescue operation had failed ignominiously; the overall state of America's military was weaker than at any time since World War II; and the European consensus held that the North Atlantic Treaty Organization would break up. Russia's move into Afghanistan seemed like the penultimate blow to American power. If America ceased to be the leader of the free world, the dollar also would cease to be the world's reserve currency. The cost of options on America's funeral - for that is what the gold price was - went through the ceiling.
(Excerpt) Read more at atimes.com ...
Inflation means that the dollar is becoming worth less relative to other assets. Deflation infers the opposite, that the dollar is becoming worth more relative to other assets. Considering the new new spending and debt incurred by Obama and congress, deflation seems unlikely. Market economics dictate that as supply increases, cost (value) decreases. Debt increases the market supply of dollars, thereby decreasing their value. What you are suggesting is that somehow the dollar is increasing in value even as trillions of new dollars are being put on the market due to deficit spending. That is illogical.
No, the quantity of dollars in existence is not the only variable determining the exchange value of dollars.
The value of many other assets, including virtually all long dated ("investment") claims, and anything with more *risk* than money, has fallen violently, in case you hadn't noticed. It is not possible for the value of most assets to fall in money terms without the exchange value of money increasing.
Yes, increasing the supply of any commodity reduces its exchange value *if everything else is held constant*. This is *not* a statement about the total direction of the exchange value of that commodity, it is a statement about its *first partial derivative*, and with respect to *one* variable.
The value of any commodity depends on *demand* for that commodity, as well as the supply of it.
The demand for *money* is *not* a constant.
One, the demand for money for transactional purposes changes with overall wealth. Two, the *investment demand* for *savings* forms of money, as an *asset class* competing with *other* assets, not for immediate spending, depends on the *risk tolerance* of asset owners, and on the prices and returns offered by all other assets.
Money is not wealth. Money is a single narrow asset class that comprises only a small fraction of men's wealth.
Movements in other assets much larger than money, may outweigh the changes in the supply of money, in effect on its price. Those changes act through the demand for money.
Concretely and empirically, the value of all assets owned by the US household sector was *$12.2 trillion less* at the end of the 1st quarter of 2009, than its total at the end of 2006. They owned $1.1 trillion more in *bank deposits and CDs*, yes. But they owned $4 trillion less in real estate equity, $4 trillion less in stock, $3 trillion less in their pension funds and 401ks, $1 trillion less in mutual fund shares, and $1 trillion less in equity in unincorporated small businesses (including professional offices and partnerships etc).
To believe that their extra $1.1 trillion in CDs will outweigh their $12.2 trillion less in everything else, in their future spending behavior, is to make a fetish of money as somehow magical. It isn't.
US households as of the end of the 1st quarter of 2009 held slightly more than 15% of their net worth in money substitute forms, mostly CDs and money market accounts. At the end of 2006, they had held a little over 10% of their net worth in those forms.
All that is necessary for the increase in money supply seen since the end of 2006, to have no net effect the broad price level, is for the average American household to have increased its desired asset allocation for "cash", from 10% to 15%. When millions of men decided to sell real estate, stocks, commodities, and other investments, they are all issuing buy orders for money. Which is the other side of every such trade.
When demand for any commodity increases, if the supply for it does not increase in proportion, then the exchange value of that commodity will rise. If the Fed had not acted as it did last fall, the exchange value of money would have soared. How much? Well, overpriced speculative assets fell by a factor of 4. Less overpriced assets fell by a factor of 2.
In case nobody noticed, the Euro went from 1.60 early last year to 1.25 in October and again in January, at the lows of the smash. In other words, the dollar was strengthening, not weakening. This was the panic demand spike. As the Fed met that demand spike and as the panic abated, about half of that move was reversed. The same "spiderweb shock" pattern is seen in all the other major indices, oil, stocks, etc.
Broad price indices for consumer goods fell 2% over the last year. For producer goods it was larger, 4.5%, and for industrial commodities 25-50%. These are not signs that the supply of money was growing faster than demand for it. Quite the contrary, they are signs that the panic demand for money exceeded the size of the move the Fed made, though by moderate amounts.
The Fed's sheet peaked in April, the April 23rd statement in particular. Since late April, the institutions the Fed supported by short term loans, all under 3 months to run, during the crisis, have been repaying their loans to the Fed. $700 billion has flowed back to the Fed in that period. The largest items are direct credit to banks, dollar loans to foreign central banks on swap lines (used to support the dollar accounts of European banks in particular), and commercial paper lending. The Fed has reinvested most but not all of that returning money into treasuries, agencies, and mortgage backed securities, in a 40-10-50 ratio.
Next, as to deficit spending rather than Fed action. First, treasury sales of bonds do not increase the money supply. They move it from public investors, through the treasury, to whoever receives the government spending as their own receipt. From the standpoint of the investors, they are exchanging a dollar bank deposit for a treasury note, typically lower in maturity. The dollars wind up back in the banking system once received by reciepients of government spending. It is Fed actions that create new dollars, not treasury actions.
Now as to whether the treasury issuance has greatly exceeded demand. If it had, then the sign would have been falling prices for treasuries, and higher rates. The treasury has placed $1.5 trillion in net new debt at interest rates under 3% (blended cost). Its auctions continue to be oversubscribed. No this is not all just going to the Fed, private domestic investors have taken 2/3rds of it and the Fed about 1/7, as redeployment of some of the sums being repaid to it as discussed above.
Rates rose from their panic lows in December but have been broadly stable since the March lows in stocks, bouncing between 3.25 and 4%. They were at 4% before the late summer break in the market last year, so they are down not up overall. TIPS show inflation expectations at 2% long term and less than that over the next decade.
These are not signs that the debt issued greatly exceeded the demand. The reality is practically every institution on the planet is attempting to lower their credit risk exposure at this time. This shows up as falls in the values of riskier assets, in wider than normal credit spreads, and in sustained high demand for US treasuries over other forms of investment. The treasury is not acting to meet this demand, it is reacting to its own funding needs as its tax receipts fell and its spending rose. But the safety demand for treasuries is there, just the same.
Whenever the demand for a commodity increases, if suppliers of that commodity provide more of it, they add net value to the entire society. If instead they refuse to do so, then they provide a windfall to existing holders of that commodity, but add nothing to the net value of the whole society. The demand that the Fed create no new money when demand for money spikes, is a demand for a windfall to existing holders of money (in the form of a falling price level); the demand that the Treasury issue no bonds when demand for safer investments spikes, is a demand for a windfall to existing holders of treasury bonds.
Both were actually seen, especially at the lows of the market. Holders of safe bank deposits received opportunities to buy long term corporate bonds at 12-15%, opportunities to buy real estate for half peak levels, and opportunities to buy commodities and stocks at 1/2 to 2/3rds present levels. Holders of US treasuries received a plus 20% return in a year in which everyone else saw -40 to -50% returns. Holders of dollars could exchange them for Euros for 4/3rds as much as earlier last year. All of these moves have since reversed by about half, as it perfectly normal in rapid price adjustments, where the direction is known but not, initially, the proper scale, until the movement finds an balancing price.
The Fed knows what it is doing.
"Gosh, there is more money, so there must be hyperinflation right around the corner", is not economics, nor logic. It is merely a crude oversimplification that ignores what is actually happening. Other things are not equal when they mean a drop of $12 trillion in asset values.
Men contracted large debts to carry real assets from houses to shopping malls to oil futures to stocks, in the belief that all of those assets they could hit with a stick must end up worth more than the dollar claims written against them. They were wrong. When prices shoot to unsustainable heights, they will not be sustained, they will fall. Overpredicting an inflation that does not happen is precisely what such asset bubbles *are*. And they end.
It's a deflation. The Fed has taken the worst edge off of that deflation. It is perfectly sensible to worry about reckless federal spending going forward. But no, there is no hyperinflation and there isn't going to be, and those screaming that there must be, are making the exact same mistake that was the bubble.
None of the actions taken by the Fed to date have been directed at accomodating the treasury. All of it has been directed at accomodating the banks. The Fed doesn't own any more treasuries today than it did back before the crisis, 2 years ago. It sold off much of its treasury holdings to finance its early support for the banks, between Bear and Lehman. It has rebuilt the position in had since then, as the banks have repaid it. It is done its treasury buy commitments as well; it still has several hundred billion left to do in mortgage backeds.
The only net new positions on its sheet are the minor grab bag of bailout residue (about $100 billion), and a huge new position in mortgage backed securities. The last is around $700 billion and may go to a trillion by the time they are done for the cycle. In case everyone forgot, Fannie and Freddie are in receivorship, so the added demand from that mortgage position is less than it may seem; actions the agencies took previously, the Fed is taking now.
As for monetary policy for revenue rather than to steer the macro economy, it hasn't been the practice in this country since the Korean war. It was done as a war finance measure with treasury short rates effectively fixed; but so were practically all bank rates, and banks were forbidden to offer interest on checkable money then. (It was only possible despite foreign central banks being able to redeem dollars in gold, because it was done in moderation - federal revenue came from other sources and from borrowing for the most part - and because the US owned half the planet).
Eisenhower ended that completely and no one has gone back to it. Even in the 70s inflation, it wasn't the treasury or its needs, but unemployment targeting by Keynesians looking at macroeconomic indicators, that drove inflation higher.
Sound central banks only issue money when they can buy something for it that they believe has real value and will keep it over time. That is what makes hard currencies hard, at bottom. For every dollar of physical federal reserve notes outstanding, the Fed currently has on hand about 30 cents in gold and $1.50 in bonds, split between treasuries and mortgage backeds. If the treasury never paid a cent on its debts, they'd still be fully backed by other assets worth more than they are.
Anybody who thinks Zimbabwe gets its inflation doing that doesn't understand banking (or Africa, come to that). Sound central banks only issue money against valuable assets, unsound ones issue money as a one sided transaction without regard to anything else.
As for tax receipts continuing to fall, they won't. The economy turns and they come back up. That will still leave a wide deficit gap, but tax receipts will rise somewhat faster than the economy does going forward.
As for spending rising (you said "liabilities" which I'll get to in a second), it won't. The TARP was a one-off, and will not recur in next year's budget, and wasn't an income cost to begin with. Large portions of it were never issued and aren't going to be. E.g. Fannie and Freddie had $400 billion set aside for them and have only drawn $75 billion. They might top out there or at $100 billion, but nowhere near $400 billion, which was just there as a "more than enough" to reassure investors in agency securities.
Fannie and Freddie are going to earn all of it out over 3-5 years and repay gradually, but that drain is stopped already and will reverse. The banks have repaid roughly half their TARP money and will repay the rest. (The autos were a populist boondoggle and that money is gone; AIG will take longer and could be anwhere from no loss to minus $100 billion long term).
The bottom line on first round TARP will come in at a true treasury cost less than a fifth the figure booked for last year, not a per year expense forever.
The "stimulus package" included some second round versions of that and plenty of boondoggle. But much of it hasn't been spent, and only will be over several years. That one doesn't recur as a budget item either.
Throw those out and the budget is still out of balance, but by typical recession amounts.
Obama is still capable of screwing things up with massive net tax increases or massive new entitlements we can't afford or both. But politically he looks stalemated on those subjects about now. He might get more political capital to spend as the economy recovers, something the right really isn't prepared for but will happen. Depends on the speed of that on the one hand, and populist-political lag on the other. (Unemployment will be the slowest to improve, after markets first and GDP second, for example).
Stop massive new spending and there is nothing much to worry about. The ship is big and the move was violent, but it will right itself. Everyhing actually needed was in place the day Bush left office. Obama's two big chances to screw it up royally were picking a treasury secretary and the Bernanke reappointment decision. He played it cautious on both counts.
It is of course not economics of any kind to call for giant new taxes on energy and small business at the bottom of a recession. If anyone thinks it is Keynesian, it'd make him spin in his grave. But barring such nonsense passing a pressured and unpopular congress in a by-election year, the worst is behind.
I hope this is useful...
Interest was paid on gold deposits prior to the 1933 confiscation, although rates under the gold standard were fairly low. So, the only real reason gold doesn’t pay interest is because the government forbade it! I’m no goldbug, but thems the facts.
None of it is the point. The point was merely that bonds denominated in a fiat currency do tend to hold their value over time, interest in, even if fiat money stuffed in a cookie jar does. The reason is obvious - men demand higher interest when inflation is higher, so real rates tend to at least zero in the logn run, and this economic fact is entirely independent of the monetary system. Markets and men's motivations, not laws, decide such things.
Government "forbade" interest on checking accounts too. It just differentiated one kind of account from another, it didn't prevent bank accounts that earn interest, or spending from interest bearing accounts. Clumsy regulations can change forms but they do not touch economic substance. Which, same as it ever was, is up to the contracting parties to set any way they please.
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