Tag: economics

Credit is money

Shades of the old inflation/deflation debate. Zerohedge points out the vast imbalance between credit money and cash.

1)   The total currency (actual cash in the form of bills and coins) in the US financial system is a little over $1.36 trillion

2)   When you include digital money sitting in short-term accounts and long-term accounts then you’re talking about roughly $10 trillion in “money” in the financial system.

3)   In contrast, the money in the US stock market (equity shares in publicly traded companies) is over $20 trillion in size.

4)   The US bond market  (money that has been lent to corporations, municipal Governments, State Governments, and the Federal Government) is almost twice this at $38 trillion

5)   Total Credit Market Instruments (mortgages, collateralized debt obligations, junk bonds, commercial paper and other digitally-based “money” that is based on debt) is even larger $58.7 trillion.

6)   Unregulated over the counter derivatives traded between the big banks and corporations is north of $220 trillion

When looking over these data points, the first thing that jumps out at the viewer is that the vast bulk of “money” in the system is in the form of digital loans or credit (non-physical debt).

Put another way, actual physical money or cash (as in bills or coins you can hold in your hand) comprises less than 1% of the “money” in the financial system.

The simple facts tend to make the whole “war on cash” concept look absolutely absurd, as well as entirely obvious that it is about political control, not economic growth. The reason the central banks want to ban cash is because the credit money system is on the verge of collapse and they see it as a straw that could nevertheless cause the whole damn thing to collapse.

Which, of course, it is going to do anyhow. The map is not the territory and it will never be the territory.

A historic privilege

In his landmark economics textbook, Paul Samuelson pointed out that domestic debt did not matter in the aggregate, with one notable exception.  He wrote: “The
interest on an internal debt is paid by Americans to Americans; there
is no direct loss of goods and services. When interest on the debt is
paid out of taxation, there is no direct loss of disposable income; Paul
receives what Peter loses, and sometimes – but only sometimes – Paul
and Peter are one and the same person…. In the future, some of our
grandchildren will be giving up goods and services to other
grandchildren. That is the nub of the matter. The only way we can impose
a direct burden on the future nation as a whole is by incurring an
external debt or by passing along less capital equipment to posterity.”

Setting aside whether it matters or not who owes what to whom, the recent report on external debt owed would therefore appear to be not entirely irrelevant in this regard.

The Treasury Department says overseas ownership of U.S. debt rose 2.1 percent in March to $6.18 trillion. That is below January’s record of $6.22 trillion. China added $37.3 billion of Treasury debt, bringing its stockpile to $1.26 trillion. That’s ahead of Japan, which added just $2.5 billion, lifting its total to $1.23 trillion.

In February, Japan became the leading owner of U.S. debt for the first time since August 2008. China overtook Japan that year as the Great Recession, higher government spending and a steep drop in tax revenue pushed up U.S. government borrowing.

As of the end of 2014, US government debt outstanding stood at $13 trillion. That means that with $6.18 trillion of it owed externally, 47.5 percent of the US public debt is of the sort that, even in Keynesian/Samuelsonian terms, imposes a direct burden on the future nation as a whole. And when you consider that the future USA – one can hardly call it a “nation” at this point – will be less white, less intelligent, and less productive on average, it should be readily apparent that the economy has absolutely no chance of growing itself out of the external debt owed regardless of which economic school of thought you belong.

What we are witnessing is nothing less than the gradual demise of the biggest, wealthiest economy in world history. It is truly a privilege and an education to behold. It is rather like being able to witness the death of the last Tyrannosaurus Rex. Regardless of how the fallout from the event may affect us personally, we have seen and experienced something that very few men have ever known.

I still remember living in Japan at the height of the Heisei Boom; I flew out of Narita less than five months before the consumption tax and the first round of monetary tightening marked the peak of that Golden Age and brought it to an end. In nearly three decades since, Japan has never again approached those heights of ease and luxury. Now we are looking at much the same thing, albeit on a considerably larger scale. But rather than mourn the recent past, we should appreciate it for the rare moment in history it was.

The Hobbesian Law was never abolished, it was merely held in abeyance for a time.

Christianity: the predictive model

It’s somewhat remarkable that so many people refuse to grant the Bible any credence when it is observably the single greatest long-term predictive document ever known to Man:

 A proposed new law in Denmark could be the first step towards an economic revolution that sees physical currencies and normal bank accounts abolished and gives governments futuristic new tools to fight the cycle of “boom and bust”.

The Danish proposal sounds innocuous enough on the surface – it would simply allow shops to refuse payments in cash and insist that customers use contactless debit cards or some other means of electronic payment.

Officially, the aim is to ease “administrative and financial burdens”, such as the cost of hiring a security service to send cash to the bank, and is part of a programme of reforms aimed at boosting growth – there is evidence that high cash usage in an economy acts as a drag.

But the move could be a key moment in the advent of “cashless societies”. And once all money exists only in bank accounts – monitored, or even directly controlled by the government – the authorities will be able to encourage us to spend more when the economy slows, or spend less when it is overheating.

The idea that “high cash usage” in an economy acts as a drag is absolutely and utterly absurd when examined from the perspective of several economic schools. Even the Keynesian school, which will be in favor of banning cash in favor of more easily manufactured nonexistent numbers, teaches that Savings = Investment. Is getting rid of savings, and therefore investment, really going to strengthen the economy?

What this is really designed to do is to address the problem seen in the chart from yesterday’s post that shows the massive decline in debt growth from 1985 to 2015. As the production of credit money declines with the inability of consumers and corporations to take on more debt, other less productive sources are being tapped to keep the government beast alive. Hence their pursuit of even the coins under granny’s couch.

The real nightmare isn’t the economic abomination of the authorities playing a disastrous push-pull with the entirety of the money supply, though, it is the establishment of the infrastructure for the long-predicted Mark of the Beast. And it would be very interesting to hear a disbeliever explain how such an unlikely creation could have been envisioned so clearly nearly two thousand years ago.

Irrelevant equilibriums

While I agree with Ari Andricopoulos’s observation of the danger of the Taylor rule as well as the utter ineptitude and irrelevance of the whole orthodox macroeconomic profession, this post somehow tends to remind me of Princess Leia pointing out how the tighter the Empire grasped, the more star systems would slip through its hands.

Equilibrium: γ*ES  = (1-αd)*d + (1-αi)*i + (1-αw)*w + (1-αC)*C  (3)

This means that the spending of existing savings exactly matches the amount being saved without any new debt being taken out. This is the true equilibrium in an economy that we need to aim for.

In any case, you can see how the dividends, interest and wages from GDP at time t, as well as the external sources of money (from existing savings, new loans and new central bank money) make up the next period nominal GDP.

What has gone wrong:

I would say that during the 1945 to 1975 period, a period of excellent growth across the developed world, we were broadly in equilibrium. The savings broadly matched the spending of exisiting savings. Governments, using Keynesian policy tools would increase their spending (the government component of L) when savings were too high and reduce when more savings were being spent than new savings made. It all worked pretty well.

What changed in the 1970s was the rise of credit. Looking at the Equilibrium equation (3) above, the share of GDP going to interest and dividends went up relative to the share going to wages. The coefficients of consumption (α) for the interest and dividends is lower than that for wages so we had the following inequality:

γ*ES  < (1-αd)*d + (1-αi)*i + (1-αw)*w + (1-αC)*C

This means that the economy is out of equilibrium. The GDP shown in figure 1, will now go down because of the excess savings.

Previously fiscal policy would have been used to stimulate growth and return the system to equilibrium.

Increased government debt is far more efficient at stimulating the economy than increased private sector debt. I show here that a 10% net increase in private sector debt stimulates the economy and adds approximately 1.1% to GDP growth in the year that the debt is taken out. So the multiplier of private sector debt to GDP here is 11%. However, the cost in future years due to the increase of interest repayments at the expense of wages is 0.15% of GDP for every year going forwards.

The same amount of increased government debt costs only 0.9% of GDP going forwards, but crucially the multiplier on this spending is much higher. Therefore much less government debt is needed to create the same amount of economic stimulus as private sector debt. In fact, I estimate that government debt is an order of magnitude more efficient.

 One problem with the Taylor rule is that it uses a linear trend extrapolation. But the increase in debt means that the growth potential of the economy is lower each year so trying to keep it at the previous trend means more and more debt.

Another point which I disagree on, is that the inflation targeting does not separate inflation with a domestic source compared to that with a foreign source. I discuss the error that I believe that they are making here.

But the main problem is that, as with the whole orthodox macroeconomic profession it seems, is that IT IGNORES PRIVATE SECTOR DEBT.

I can not stress how obvious this is. It assumes that debt can grow indefinitely. It assumes that previous debt has no impact on growth. It creates a positively reinforcing feedback mechanism that ends in stagnation.

This is the real danger of the Taylor rule, Dr Bernanke.

Far from the mainstream notion that private sector debt is irrelevant, I would argue that it makes more sense to measure the macroeconomy – to the extent that we bother pretending it even exists, which is the subject for another day – in credit money. This method would have its flaws, of course, because credit money can evaporate in a heartbeat, but it would have the benefit of providing a much more accurate snapshot of any given moment in macroeconomic activity than the woefully irrelevant Samuelsonian GDP model.

This observation on the negative correlation between private sector debt and GDP growth by Dr. Andricopoulos should be particularly educational for empiricists:

A few weeks ago I wrote this post which showed the results of my empirical study on the effect of private sector debt on the economy. It found that a 10% increase in the level of private sector debt corresponded to a 0.15% decrease in GDP growth every year going forwards. Considering that the levels of private sector debt in many advanced economies is around the 200% level, this is a pretty big drag and on its own would explain the current secular stagnation.

Now, according to the Keynesians and Neo-Keynesians, this shouldn’t be any more possible than the stagflation of the 1970s. Once more, even by its own supposedly empirical standards, Keynesianism, or more properly, Samuelsoniansim, is seen to be a failure.

It’s also worth noting that even Dr. Andricopoulus’s history is an inaccurate summary, at least as far as the USA goes. Below is a chart showing the annual growth of total public and private sector debt, aka “credit money”, in the US economy from 1948 through 2014. Where is this sudden “rise of credit” that is supposed to have taken place in the 1970s? Is it the increase from 8.58 percent in 1969 to a peak of 16.03 percent in 1985?

Debt and particle acceleration

This is an interesting and intriguingly simple way of explaining the debt-deflation cycle:

The scientists at CERN can create matter from nothing only if they also create its offsetting opposite anti-matter. Similarly banks are only able to create money from thin air provided they create, at the same time, the offsetting opposite amount of anti-money, otherwise known as debt.

In short our modern banks are the particle accelerators of the financial system. They conjure money and anti-money, fortunes and debts, from nothing.

It is informative to extend this analogy a little further. When particles and anti-particles are created from nothing energy is ‘consumed’ and when they later recombine to annihilate one another this energy is then re-released. There is an analogous, though opposite, process of energy capture and release associated with the creation and destruction of money and debt.

When a bank makes a loan it splits zero into a fortune (money) and its equivalent debt. This process releases new spending power into the economy producing a burst of economic energy. Conversely when, at a later date, the money is recombined to annihilate the debt, both money and debt vanish and an equivalent amount of spending power, economic energy, is withdrawn from the economy.

At any given time, if the amount of credit being created roughly balances with the amount being destroyed the spending power within the economy will remain roughly constant and the economy will be stable. On the other hand, if there is an imbalance between credit creation and credit destruction the economy will be unstable. An excess of credit creation – new money and new debt – will amplify economic activity. Conversely an excess of credit destruction – repaying old debts – will attenuate economic activity.

From the remorseless logic of Brahmagupta’s mathematics it follows, any economic boom generated by high levels of debt creation will have the seeds of its own destruction within it. These credit-creation fuelled booms will inevitably lead to their partner, a credit-destruction driven bust – otherwise known as a debt deflation cycle.

This simple way of thinking about how our monetary and banking system works helps explain what has gone wrong with monetary policy over recent years… Our own voting patterns have trained our political leaders, like Pavlov’s dog, to seek a relentless but ultimately unsustainable credit expansion. However, when policy makers seek to engineer an economic boost through credit expansion they are also, due to the mathematics of Brahmagupta, engineering a future economic slump. This helps us understand where the deflationary forces currently taking hold in the Eurozone have come from. These are, in large part, the inevitable consequence of previous monetary policy designed to engineer credit expansion.

The next time you see the term ‘Money Supply Growth’ it may be worth pausing for a moment to reflect on the ideas of an obscure 7th century Indian mathematician and think instead of the term ‘Debt Supply Growth’.

This should help explain why you simply cannot borrow or spend your way out of debt. It’s like trying to dry yourself off by jumping in the pool. It’s a logical contradiction, no matter how convincingly economists like Ben Bernanke and Paul Krugman manage to dance in circles, draw epicycles, and dazzle you into thinking they are speaking anything but utter nonsense.

I think I can explain it even more simply, however. Money is a measure. And no matter how you may redefine the “inch” by making it increasingly smaller on the ruler, you do not make the object measured any longer.

Best Novel 2016

Ben Bernanke isn’t talking to us in the title of his new account of the 2008 financial crisisnovel, he’s talking to the gentlemen paying his speaker’s fees.

“When the economic well-being of their nation demanded a strong and creative response, my colleagues at the Federal Reserve, policymakers and staff alike, mustered the moral courage to do what was necessary, often in the face of bitter criticism and condemnation. I am grateful to all of them.”

As with all Fedspeak, you have to translate it into English. What he so bravely did was bail out the owners of the large banks at the cost of the US economy. The USA will now never exit the debt-prison into which Helicopter Ben locked it without a catastrophic meltdown.

I think we’re going to need to get a ruling from MidAmeriCon if The Courage to Act will be eligible for Best Novel next year. It certainly contains more fiction than the average fantasy novel.

Closing the work gap

Be careful what you wish for. The top ten countries with the lowest male-female labor force participation gaps:

  1. Togo
  2. Rwanda
  3. Burundi
  4. Tanzania
  5. Congo
  6. Laos
  7. Myanmar
  8. Sierra Leone
  9. Malawi
  10. Uganda

This suggests advocates might like to do well to reconsider whether closing the wage gap is truly an objective worth pursuing.

“Gee, Jane, isn’t it swell that we both make exactly the same wages now?”

“Well, Bob, as you know, it’s tough to make it on five cents per day.”

“But we have this lovely mud hut! And each other!”

“Yeah, about that, Bob. Human Resources told me that all monoracial heterosex is rape. So I’m going to need you to move out. Shaneeqwa from Marketing is moving in, and, by the way, Payroll is going to send three cents of your daily wages to me starting tomorrow.

No income growth in two decades

Despite two stock market booms, there has been no real income growth since 1994:

Real Median Household Income Has Been Flat for 20 YearsDespite ultra-loose monetary policies over the past several years,
incomes adjusted for inflation have fallen for the median U.S. family.
With the benefits of monetary expansion going to a small share of the
population and wage growth stagnating, incomes have been essentially
flat over the past 20 years. In the long run, however, classical economics would tell us that the
pricing distortions created by the current global regimes of QE will
lead to a suboptimal allocation of capital and investment, which will
result in lower output and lower standards of living over time. In fact,
although U.S. equity prices are setting record highs, real median
household incomes are 9 percent lower than 1999 highs. The report from
Bank of America Merrill Lynch plainly supports the conclusion that QE
and the associated currency depreciation is not leading to higher global
output. The cost of QE is greater than the income lost to savers and
investors. The long-term consequence of the new monetary orthodoxy is
likely to permanently impair living standards for generations to come
while creating a false illusion of reviving prosperity.

Karl Denninger was among the first to point out that even if it worked, Quantitative Easing could not possibly do what was claimed of it. Thus demonstrating what I pointed out, which is that it was merely about buying more time for the bankers to make hay before the eventual crash of the global economy. We’re already seeing signs of the wars that conventionally accompany depressions, and depending upon your definition of depression, we’re only six years into this thing.

The inequality of austerity

For all the talk about the “idle poor” and lazy Greeks, let’s not forget that corporate welfare to the “idle rich” and politically connected Greeks is often rather substantial. That’s not just a left-wing talking point, in this age of banking bailouts, the subsidies to the very rich may actually exceed those to the overtly government dependent. It’s clear that the burden imposed by the IMF is not falling, like the rain, on the rich and poor alike.

Greece’s unbalanced austerity and drastic increase of poverty. The poorest households in the debt-ridden country lost nearly 86% of their income, while the richest lost only 17-20%.  The tax burden on the poor increased by 337% while the burden on upper-income classes increased by only 9% !!! This is the result of a study that has analyzed 260.000 tax and income data from the years 2008 – 2012.

According to the study commissioned by the German Institute for Macroeconomic Research (IMK) affiliated with the Hans Böckler Foundation:

– The nominal gross income of Greek households decreased by almost a quarter in only four years.

– The wages cuts caused nearly half of the decline.

– The net income fell further by almost 9 percent, because the tax burden was significantly increased

When you see statistics like that, you sort of assume that there will be some sort of revolution taking place, and frankly, it would be hard to blame them. Crony “capitalism” of the sort we’ve seen dominate the Western economies since 2008 is not something that any genuine capitalist should support.

Taleb corrects Pinker

He observes that Pinker has been fooled by randomness and The “Long Peace” is a Statistical Illusion:

When I finished writing The Black Swan, in 2006, I was confronted with ideas of “great moderation”, by people who did not realize that the process was getting fatter and fatter tails (from operational and financial, leverage, complexity, interdependence, etc.), meaning fewer but deeper departures from the mean. The fact that nuclear bombs explode less often that regular shells does not make them safer. Needless to say that with the arrival of the events of 2008, I did not have to explain myself too much. Nevertheless people in economics are still using the methods that led to the “great moderation” narrative, and Bernanke, the protagonist of the theory, had his mandate renewed.

Now to my horror I saw an identical theory of great moderation produced by Steven Pinker with the same naive statistically derived discussions (>700 pages of them!).

  1. I agree that diabetes is a bigger risk than murder –we are victims of sensationalism. But our suckerdom for overblown narratives of violence does not imply that the risks of large scale violent shocks have declined. (The same as in economics, people’s mapping of risks are out of sync and they underestimate large deviations). We are just bad at evaluating risks. 
  2. Pinker conflates nonscalable Mediocristan (death from encounters with simple weapons) with scalable Extremistan (death from heavy shells and nuclear weapons). The two have markedly distinct statistical properties. Yet he uses statistics of one to make inferences about the other. And the book does not realize the core difference between scalable/nonscalable (although he tried to define powerlaws). He claims that crime has dropped, which does not mean anything concerning casualties from violent conflict.
  3. Another way to see the conflation, Pinker works with a times series process without dealing with the notion of temporal homogeneity. Ancestral man had no nuclear weapons, so it is downright foolish to assume the statistics of conflicts in the 14th century can apply to the 21st. A mean person with a stick is categorically different from a mean person with a nuclear weapon, so the emphasis should be on the weapon and not exclusively on the psychological makup of the person.
  4. The statistical discussions are disturbingly amateurish, which would not be a problem except that the point of his book is statistical. Pinker misdefines fat tails by talking about probability not contribution of rare events to the higher moments; he somehow himself accepts powerlaws, with low exponents, but he does not connect the dots that, if true, statistics can allow no claim about the mean of the process. Further, he assumes that data reveals its properties without inferential errors. He talks about the process switching from 80/20 to 80/02, when the first has a tail exponent of 1.16, and the other 1.06, meaning they are statistically indistinguishable. (Errors in computation of tail exponents are at least .6, so this discussion is noise, and as shown in [1], [2], it is lower than 1. (It is an error to talk 80/20 and derive the statistics of cumulative contributions from samples rather than fit exponents; an 80/20 style statement is interpolative from the existing sample, hence biased to clip the tail, while exponents extrapolate.)
  5. He completely misses the survivorship biases (which I called the Casanova effect) that make an observation by an observer whose survival depends on the observation invalid probabilistically, or to the least, biased favorably. Had a nuclear event taken place Signor Pinker would not have been able to write the book.
  6. He calls John Gray’s critique “anecdotal”, yet it is more powerful statistically (argument of via negativa) than his >700 pages of pseudostats.
  7. Psychologically, he complains about the lurid leading people to make inferences about the state of the system, yet he uses lurid arguments to make his point.
  8. You can look at the data he presents and actually see a rise in war effects, comparing pre-1914 to post 1914.
  9. Recursing a Bit (Point added Nov 8): Had a book proclaiming The Long Peace been published in 1913-1934 it would carry similar arguments to those in Pinker’s book.

Taleb is using a different means to reach much the same conclusions I have. Again. Pinker is essentially applying the same “This Time It’s Different” argument to violence that the mainstream economists applied to the dot com bubble, the housing boom, and the post-2008 “recovery”.

Simplistic thinkers inevitably think in linear terms. They assume tomorrow will be like today because today was pretty much like yesterday. Both those who know history and those who understand probability understand that at some point in time, this will no longer be the case.

History is rife with long periods of peace and tranquility. Those are quite often the sections missing from the history books, because there was nothing much that was noteworthy to record. But human nature being what it is, sooner or later events always becoming more exciting, which usually means more bloody.

It’s not hard to understand why there are fewer wars these days. Nuclear weapons have put an end to the post-French Revolutionary progress towards Ludendorffian total war. But that doesn’t mean they will never be used or that Man will not find other means to fight cataclysmic wars. It’s rather remarkable that anyone would make such abysmally stupid claims about the prospects for the continuation of the “Long Peace” when the USA is moving rapidly towards ethnic civil war, Europe is preparing for extreme ethnic cleansing, and the Dar al-Islam is in the process of uniting under a new and aggressive Caliphate even as the USA attempts to instigate war with Russia.