Brian Kelly

Quantitative Easing: Money Supply Is Actually Decreasing

Perhaps I am missing what you are asking, but this is my answer to how I understand your question:

When the IOU is written off, whoever holds the paper no longer can claim that as an asset - therefore this asset cannot be securitized and thus "money" is destroyed.

In terms of double counting, I think what you may be referring to is the multiplier effect. i.e. each dollar in the system is used for many purposes.


I hope that clarifies/answers? My apologies if I have made it more confusing.




On Mar 23 03:11 PM Barbarous Relic wrote:

> Brian Kelly - "The IOUs written are not against existing cash they
> are a way to pull cash out of an asset, in this way the asset is
> said to be "monetized". A good example is a home equity loan. Excess
> equity is simply the perception of an increased value of a home.
> It is money only in the sense that you can go to a bank and get cash
> (line of credit) that you previously did not have."
>
> This example merely describes a bank making me a loan. Under our
> fractional reserve system this does represent new money creation.
> I totally agree with that.
>
> But if we then add that $100 IOU on the bank's balance sheet to the
> $100 I now have in my pocket to get $200, it seems to me that we're
> double counting. If the IOU ultimately gets written off, I still
> have the $100 I borrowed -- no money was destroyed. What am I missing?

Quantitative Easing: Money Supply Is Actually Decreasing

The IOUs written are not against existing cash they are a way to pull cash out of an asset, in this way the asset is said to be "monetized".

A good example is a home equity loan. Excess equity is simply the perception of an increased value of a home. It is money only in the sense that you can go to a bank and get cash (line of credit) that you previously did not have.

When the asset price falls ,the value of money falls, since the value of that money was initial priced from the value of the asset.

This is circular logic that got in this mess.



On Mar 23 01:50 PM Barbarous Relic wrote:

> I'm trying to understand why credit instruments should be added to
> conventional money supply measures to get a truer picture.
>
> When a credit instrument is issued, it is an IOU given in exchange
> for existing money. If the IOU is written off, it is simply a recognition
> that the debt is unlikely to be repaid -- however no "money" has
> been destroyed in the process. Both a receivable and a payable effectively
> vanish from the system. Where do I go wrong in my thinking?

Quantitative Easing: Money Supply Is Actually Decreasing

My optimism for sound growth assumes that the financial landscape will change - by that I mean the so called "zombie" banks will cease to exists.

I agree that keeping these institutions alive is simply repeating the mistakes of the past. Until the Govt and the banks admit they made bad loans then we will continue to wallow. Unfortunately, we got another program today (PPIP) that keeps the denial alive.


On Mar 23 01:10 PM axelrod608 wrote:

> >> "As I see it, the goal of these programs should be to rebuild
> the financial infrastructure which has been badly damaged. This will
> take a while and the financial landscape will look vastly different
> when we are through rebuilding, but if done properly it could provide
> a very solid foundation for growth." >>
>
> Adding non-money derivatives to money does not increase money. It
> merely points out the unsustainability of the financial system circa
> 2000 - 2006. Those amounts were the bubble, the highly leveraged
> unsustainable bubble.
>
> Helping the "too big to fail" companies will recreate what the Japanese
> did - keep zombie banks in operation that were not necessary for
> the new conditions. I call it government sponsored unsustainability.
>
>
> Your optimism regarding a solid foundation for future growth is unwarranted.
> The zombies we are now creating will continue to provide no growth
> and will continue to hemmorhage losses for another several years,
> adding to unemployment and the national debt.
>
> I'm not too worried about hyperinflation. I see the toxic assets
> as quicksand, swallowing the new money as fast as it's poured in.
>
>
> I hope I'm wrong. I would love to see this mess get fixed and the
> return of economic good times. Unfortunately, I see no economic
> data or trends to support that premise.

Quantitative Easing: Money Supply Is Actually Decreasing

I agree that restoration of the consumer will be gradual which is one reason I do not think we are looking at hyperinflation.

As I see it, the goal of these programs should be to rebuild the financial infrastructure which has been badly damaged. This will take a while and the financial landscape will look vastly different when we are through rebuilding, but if done properly it could provide a very solid foundation for growth.


On Mar 23 11:53 AM Alphameister wrote:

> Excellent, highly insightful article and follow-up comment, Brian.
> It seems to me, though, that people are resistant to radical change.
> If and as panic subsides and consumers have achieved marginal improvements
> in their balance sheets, that propensity to consume will find them
> gradually increasing their spending both through cash and credit,
> increasing both the money supply (through credit) and the turnover
> rate (velocity) of money. I think the goal of these programs is
> not to push consumers and companies still deeper into debt but rather
> to allow the restoration of balance sheets to take place gradually
> rather than precipitously. Any comments?

Quantitative Easing: Money Supply Is Actually Decreasing

It will become money again if the markets thaw out, which is yet to be seen.

There is also another side to this equation, and that is the demand for credit. Even if the securitization market functions again, it is unlikely it will get to the levels seen in 2007 since both companies and individuals are reluctant and/or unable to assume more debt.

Therefore, it is possible that my crude estimate of "aggregate" money supply will not grow despite the TALF. The TALF plan is based on the assumption that demand for credit increases in direct proportion to money supply. I would argue that this assumption does not necessarily hold in the real world.



On Mar 23 10:47 AM Fairway Jack wrote:

> I think you are saying that the money supply is de facto decreasing
> because purchasing power generated by asset backed securities is
> more or less frozen due to the present econmic situation. OK...I
> see your point but won't the securitized credit become money again
> once the panic / fear subsides...and then jump into the pool of money
> being printed now for an even bigger ocean of money at some future
> date ??

Waiting for Inflation? It May Take Awhile

Bartlesby

That is a very good point, the destruction of financial system as we know it will likely have impacts not considered. For example, how much did securitization contribute to GDP and the potential GDP estimates.


On Feb 25 06:41 PM Bartlesby wrote:

> We must also consider the possibility that these shifts in short
> run supply and demand are structural and not just cyclical, in which
> case we are witnessing a reduction in long run GDP supply (i.e. potential
> output).
>
> If this is the case, your output gap discussed here may actually
> be smaller than you think.

Waiting for Inflation? It May Take Awhile

yes--i agree that the last 50 years are not the best reference for what we are experiencing. We are experiencing something as bad or worse than the depression.

However, what the last 20-30 years does have is a central bank that actively targets inflation - and central bank policy has had a major impact on inflation. If you look at the chart of CPI you can see that since Volcker made it popular to stamp out inflation in the 1980's we have not seen extreme spikes.


On Feb 25 09:28 AM User 143167 wrote:

> What you should really look into in 1930s and 1940s, when interval
> between monetary inflaiton and CPI inflation was short. Also you
> can look into the age between 1870s and 1920s, the intervals were
> even shorter.
> We are now in a scenario that you can't find reference in the past
> 50 years. So I would skip over those decades.

Waiting for Inflation? It May Take Awhile

CPI - I did not use core CPI - I have never understood why the Fed focuses on core numbers --- if oil and food go up, I still have to eat and drive my car, so I can't exclude them, it does not make sense to exclude them from policy decisions.

Imported Consumption - as with any economic analysis, looking at one number in a vacuum can be dangerous. I am just presenting one part of the equation -- although it is a big part.

I think the bigger risk to my argument is increased consumption from China, which I assume you are referencing when you ask about "external demand". If the Chinese stimulus package succeeds in creating internal demand in China then all the spare capacity we have is not going to matter.

For now my chips are placed on weak exports keeping Chinese demand in check...but in these markets...things seem to change literally overnight.

Thanks for the comment.


On Feb 25 09:42 AM Hmm?! wrote:

> Hold on Brian. I am not sure about your article.
>
> Waht about the fact that a large portion of US consumption is imported?
>
> What about external demand for resources? What about a devalued dollar
> increasing the cost of both items above?
>
> CPI? Please confirm you did not use the core CPI, which excludes
> everything that experiences price spikes.