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Friday, April 12, 2013

The perpetual motion money machine

As she is one-half of the Reinhart-Roghoff team that has done some excellent work concerning why what Alan Greenspan once called the New Economy was not, in fact, anything new or different, I'm always interested in what Carmen Reinhart has to say.  I don't necessarily agree with her on policy prescriptions, but her diagnostic take is usually insightful. She was interviewed by Der Spiegel last week:
SPIEGEL: Ms. Reinhart, central banks around the world are flooding the markets with cheap money in order to spur economies and support governments. Are these institutions losing their independence?
Reinhart: No central bank will admit it is keeping rates low to help governments out of their debt crises. But in fact they are bending over backwards to help governments to finance their deficits. This is nothing new in history. After World War II, there was a long phase in which central banks were subservient to governments. It has only been since the 1970s that they have become politically more independent. The pendulum seems to be swinging back as a result of the financial crisis.
SPIEGEL: Is that true of the European Central Bank as well?
Reinhart: Less than for other central banks, but yes. And the crisis isn't over yet -- not in the United States and not in Europe.
SPIEGEL: But the danger of such a central bank policy is already well known: It can lead to high inflation.
Reinhart: True. But it is certainly more difficult for a central banker to raise interest rates with a debt to gross domestic product ratio of over 100 percent than it is when this ratio stands at 39 percent. Therefore, I believe the shift towards less independence of monetary policy is not just a temporary change.
SPIEGEL: As a historian who knows the potential long-term consequences very well, doesn't such short-sighted decision-making frighten you?
Reinhart: I am not opposing this change, I am just stating it. You have to deal with the debt overhang one way or the other because the high debt levels are an impediment to growth, they paralyze the financial system and the credit process. One way to cope with this is to write off part of the debt.
SPIEGEL: You mean some kind of haircut?
Reinhart: Yes. But we are in an environment where politicians are very reluctant to do write-offs. So what happens is that money is transferred from savers to borrowers via negative interest rates.
SPIEGEL: In other words: When the inflation rate is higher than the interest rates paid on the markets, the debts shrink as if by magic. The downside, though, is that this applies to the savings of normal people.
Reinhart: The technical term for this is financial repression. After World War II, all countries that had a big debt overhang relied on financial repression to avoid an explicit default. After the war, governments imposed interest rate ceilings for government bonds. Nowadays they have more sophisticated means.
The dangerous phase of the crisis that we have now entered is that even mainstream economists who understand the debt-related nature of the problem - and recall that back in 2008-2009, the only people who recognized that it was based on debt were outsiders like Steve Keen and me - are still supporting, however unenthusiastically, the attempt of the central banks to inflate their way out of the problem, even though some of them know it isn't going to work.

Why? Because they are desperate.  They know that the alternative is either default and a short but savage depression that will absolutely ruin most of the world's wealthy and powerful or the collapse of the global financial system and quite likely a fair amount of the various political structures as well. So, they are hoping against hope that the central banks will be successful in inflating their way out, but if one looks at the debt statistics, it is perfectly clear that the strategy is failing because debt/GDP is still growing.

"In the EU-27 the government debt-to-GDP ratio increased from 80.0 % at the end of 2010 to 82.5 % at the end of 2011, and in the euro area from 85.4 % to 87.3 %.... In the EU-27, total government revenue in 2011 amounted to 44.7 % of GDP (up from 44.1 % of GDP in 2010), and expenditure to 49.1 % of GDP (down from 50.6 % in 2010)."

That's the savage austerity of which the European Keynesians are complaining. Tax revenues are up 0.6 percent and government spending is down 1.5 percent, but the debt/GDP went up 2.5 percent anyhow.  This is why default, and the concomitant deflation, is inevitable, no matter how much the financial powers-that-be are desperately fighting it off.

The situation is even worse in the USA and Japan, where the government debt/GDP ratios have risen to 103 percent and 230 percent.  And while we don't know when the financial engine, increasingly clogged with debt, is going to seize up, we can be certain that sooner or later it will.  It is very unlikely that either Europe or the USA are going to be given more than 20 years to muddle along and continue piling on the debt in the manner that Japan has.

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47 Comments:

Anonymous Idle Spectator April 12, 2013 3:59 AM  

People don't need no jobs! They needs money! Lots and lots of MONEY!

Anonymous Dr. Doom April 12, 2013 4:40 AM  

Japan can still afford debt, because they still have a viable economy due to a powerful industrial sector with real assets as collateral. The USA on the other hand has NO REAL ECONOMY, and relies ENTIRELY on consumer spending and easy credit to generate revenue for the FEDGOV's death spiral of unpayable debt and shrinking taxbase.
Japan will not hyperinflate and collapse, while the USA is a carbon copy of the Disastrous Weimar Republic of Germany. Also, with an insane POTUS trying to drive the Economy of a Cliff by increasing spending on high-cost no-return projects like "Green Energy", the hyperinflation should be here soon.
China, Australia and Russia are already divesting from the US Dollar, and when the OPEC countries follow - BOOM! No more World's Reserve Currency, and the Dollar tanks to below the value of the Yen overnight!

Anonymous Ideel Spektaytur April 12, 2013 4:41 AM  

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Anonymous zen0 April 12, 2013 5:05 AM  

If Japan's recent attempt to produce 2% inflation through massive QE is unsuccessful, would that not indicate that the jig is finally up, or is more proof needed?

Anonymous Roundtine April 12, 2013 5:37 AM  

What they need to do is start printing money. Actual money, not debt. Don't buy bonds; print up money. Use the cash to buy bitcoins and send it to my wallet.

Anonymous Vetinari April 12, 2013 5:57 AM  

Dr. Doom

government securities are uncollateralized

Japanese debt is backed only by the trust that the Japanese central bank will push their computer buttons and mark up the spreadsheet entries which denote the bank balances of the owners of the bonds.

Anonymous Alarmed April 12, 2013 6:57 AM  

Blogger is chewing a hole in your third paragraph.

Blogger Son of Brock Landers April 12, 2013 7:09 AM  

The problem is that the US is a debtor nation instead of a creditor nation. We are dependent on external funding unlike Japan was after their start to the zombie banking system. This is our weakness. Debt writedowns are essential to fixing the problem, especially mortgage debt as the underlying asset 'household stock' has decreased in value by trillions. The debt should do the same.

Anonymous Stilicho April 12, 2013 7:13 AM  

One curious aspect of the crisis is that the Fed, in the latest round of QE, is directing its monetization efforts roughly 50% into Treasuries and 50% into MBS. I suspect that directing the full QE into Treasuries would result in negative nominal rates. Either way, debt monetization continues. Now, the Fed does not HAVE to monetize debt. It could, as Bernanke put it, monetize ketchup. In fact, adding hard assets (PM's, land, productive capital assets, etc.) to the Fed balance sheet would provide a sounder basis for FRN's than debt, yet it does not do so. I can only conclude that the Fed's goal is NOT a sound monetary system. Rather, its goal is to shore up the balance sheets of its member banks. This just may be intended to have the effect of directing the lion's share of the collapse toward the government and allow many of the favored banks to survive continue their vampiric feeding off of any new government(s) that arise post-collapse. Governments may come and go, but the Vampire Squid is forever.

Anonymous Outlaw X April 12, 2013 7:17 AM  

The problem is that the US is a debtor nation instead of a creditor nation. We are dependent on external funding unlike Japan was after their start to the zombie banking system.

I don't think we re a debtor nation I think our militarism is the debtor not the people. We prop up and destroy other nations and propup up illegal immigration. It is our foriegn affairs where the debt lies not the people of the nation. We don't owe most of the debt the military adventures and politicians owe it. I write it off, won't pay.

Anonymous Stilicho April 12, 2013 7:17 AM  

Question for the Ilk: how does the Fed write off worthless debt on its balance sheet? e.g. when a MBS owned by the Fed defaults. Or does it simply refuse to recognize the default/loss of nominal value?

Anonymous Outlaw X April 12, 2013 7:30 AM  

Or does it simply refuse to recognize the default/loss of nominal value?

I am strtimg to figure out it doesn't exist, they just prtend that the people owe something. China buys treasuries and they say we owe them, we don't, neither should we worry aboubt it. They have so many problems ignoring them as a people is the best otion. Giving the middle finger to any false/fake debt is the best option. It doesn't exist and never has, it is a lie written in books about economics that people believe and fear. Might as well belive in the tooth fairy as you would about national debt, it is a myth, your mom put the quarter under the pillow. The tooth was worthless.

Anonymous Cryan Ryan April 12, 2013 8:00 AM  

There once was a country without compare,
Led by masculine men, brave and fair,
But men let down their guard,
Thus we're getting it good and hard-
Most of today's voters piss through hair.

Blogger Nate April 12, 2013 8:01 AM  

***insert eye roll here***

Inevitable.

Sure. it is inevitable. It will just happen after 12 to 24 months of a hyper inflationary collapse.

Anonymous Harry April 12, 2013 8:09 AM  

Given that the Fed is not a federal agency, but a private banking consortium which has seized the right to coin/make "money" for the U.S.; and that their charging us interest on our own money is unconstitutional, we should write off the Fed and the debt as artificial debt. This is some 90% of the "national debt". Let the Central Bankers pound sand.

Anonymous Roundtine April 12, 2013 8:13 AM  

Or does it simply refuse to recognize the default/loss of nominal value?

The Fed will do as they allow the banks to do: ignore market value and claim to hold to maturity.

Blogger Nate April 12, 2013 8:14 AM  

"Given that the Fed is not a federal agency, but a private banking consortium which has seized the right to coin/make "money" for the U.S.; and that their charging us interest on our own money is unconstitutional, we should write off the Fed and the debt as artificial debt. This is some 90% of the "national debt". Let the Central Bankers pound sand."

No no... see we can't do that because... credit is money and it would be deflationary.

/facepalm

Blogger Nate April 12, 2013 8:16 AM  

" how does the Fed write off worthless debt on its balance sheet? e.g. when a MBS owned by the Fed defaults. Or does it simply refuse to recognize the default/loss of nominal value?"

It monetizes it.

Anonymous Athor Pel April 12, 2013 8:22 AM  

I can hear the war drums now. Don't you hear them too?

They're getting louder. They're getting closer.

Mars plays the drums and Mercury leads the greedy to them.

What a team those two make.


Anonymous Stilicho April 12, 2013 8:24 AM  

It monetizes it.

It was monetized when the Fed bought it in the first place for newly issued FRN's.

The Fed will do as they allow the banks to do: ignore market value and claim to hold to maturity.

That's what is going on now. My question is really one of what happens when maturity comes and no one pays or there is an outright interim default? Will they just pretend the default never happened? Those 100 year old MBS on the balance sheet? Why we're just holding them past maturity. They are still worth what we paid for them.

Anonymous E. PERLINE April 12, 2013 8:26 AM  

I'm struck that the stock markets are going up without full employment. Are the days of full employment in the private sector over?

Maybe regulations and expenses have made standard employment too costly. Maybe the US must operate on a different level.

I'm seeing people become independent subcontractors, or not reporting their earnings to the government at all. This may be an answer to red tape which has proliferated beyond all reason. But it will take politicians and economists a long time to be aware of it.

Anonymous VD April 12, 2013 8:37 AM  

No no... see we can't do that because... credit is money and it would be deflationary.

/facepalm


Let's try it this way. Do you agree that shutting down the Federal Reserve and forcing a default of all its credit would be deflationary?

Anonymous ODG April 12, 2013 8:38 AM  

"I'm struck that the stock markets are going up without full employment."

I got my tax refund back in the mail (I know - trying to change withholding...) and there was a flyer in there, offering fedgov help with investment advice! LOL!

They're pumping the market to try and maximize folks' balances before they steal them. Fattening up the calf before slaughter...

Anonymous David of One April 12, 2013 8:46 AM  

Queue scene from The Jerk with Steve Martin ... Navin R. Johnson at the carnival guessing weights: Ah...It's a profit deal. Takes the pressure off. ... Take a chance and win some crap!

Years later ...

It's not stealing. It's negative interest! Step right up and save your money!

Blogger IM2L844 April 12, 2013 8:50 AM  

They are still worth what we paid for them.

If the nominal value of an MBS is calculated using the outstanding principle balance, how is that affected by inflationary and deflationary environments? I'm just asking. I'm not sure how this works.

Anonymous Outlaw X April 12, 2013 8:50 AM  

Let's try it this way. Do you agree that shutting down the Federal Reserve and forcing a default of all its credit would be deflationary?

I hope so and hope it happens. It is a false argument in the first place because it won't happen. Inflation and deflation depend on a false monetary system. I think the better question is what happens to the people that saved all their life VS what happens to the young people trying to find a job just now. The value of labor will win out the savers will be crushed and the labor of 30-50 years will be wiped out. I think this wipe out is what they are trying to avoid.

Blogger Rahul April 12, 2013 8:52 AM  

Vox,

What about when the COMEX defaults? The dollar will lose big ground as gold goes up. The Chi-COMs will also break their dollar peg, and dollars will come home. It'll be deflation, but then it's going to be stagflation (which could turn into hyperinflation)

Anonymous Stilicho April 12, 2013 9:26 AM  

The value of labor will win out the savers will be crushed and the labor of 30-50 years will be wiped out. I think this wipe out is what they are trying to avoid.

Outlaw, if by "they" you mean the Fed in particular, or TPTB in general, it's the exact opposite. They are attacking savers in the hopes of getting the next generation into debt slavery. Savers were once viewed as the backbone of the financial system. They are now viewed as the enemy.

Anonymous Godfrey April 12, 2013 9:33 AM  

"They know that the alternative is either default and a short but savage depression that will absolutely ruin most of the world's wealthy and powerful..."


Their total focus is to protect themselves.

Anonymous Outlaw X April 12, 2013 10:07 AM  

Savers were once viewed as the backbone of the financial system. They are now viewed as the enemy.

Well, if that is true, I guess I am the enemy and if so who can depend on me anymore if they take it all away? What does economy even mean or matter any more? If they steal everything then let them live behind their gates in their disgusting world and all art goes to shit and all beauty goes to shit. Let them have their dystopic grey world because they deserve it.

Anonymous Godfrey April 12, 2013 10:27 AM  

@Outlaw X April 12, 2013 10:07 AM "What does economy even mean or matter any more?"


Well, this certainly isn’t capitalism. How can you have captialism when the formation of capital has become near meaningless and hopelessly distorted? The little captial I’ve managed to build is earning about 0% or less if inflation is considered.

In my opinion capitalism can only exist in an enviroment of sound money. It can’t exist in an enviroment werein capital can be devalued (i.e. confiscated) at the whim of politically connected banking elites.



Anonymous John Regan April 12, 2013 10:34 AM  

>>That's the savage austerity of which the European Keynesians are complaining. Tax revenues are up 0.6 percent and government spending is down 1.5 percent, but the debt/GDP went up 2.5 percent anyhow. This is why default, and the concomitant deflation, is inevitable, no matter how much the financial powers-that-be are desperately fighting it off.<<

Yes. Debt has to increase because "new" money is needed to enable already outstanding debt to be serviced, and new money can only be borrowed into existence. The only question is whether it's going to be default with forgiveness (a jubilee) or default with liquidation.

Of course the latter will be implemented first and applied to those on the bottom of the pile first. At some point, as the liquidation moves higher on the food chain the political pressure for the former will probably win out, but unfortunately not before a lot of, er, unpleasantness.

The situation is kind of impossible, from a central banker's point of view.

Anonymous Outlaw X April 12, 2013 10:46 AM  

In my opinion capitalism can only exist in an enviroment of sound money. It can’t exist in an enviroment werein capital can be devalued (i.e. confiscated) at the whim of politically connected banking elites.

I guess they never grew up. Pimple faced old men with nothing better to do. Personally, I wouldn't worry about them. There will be no John Conner to come save the world either, there doesn't need to be. Mankind is resilient and the pieces of trash will live their lives in fear. The funny thing is they don't even know what they are afraid of, like a bully in grade school they intimidate because they are insecure. Worry not.

Yeah I am talking to the monetary bullies, you lose. We are not afraid orf you, and don't even need to riot and won't li9ke the PIIGS. You lost and it don't matter what your gun control legisilation says even if it passes, no one is going to OBEY. You were the losers in highschool who ran for class president that everyone hated.

We laughed at you in the lunchrooms, bathrooms and locker rooms. You are the joke not us and just now I see you in your limo's and private jets thinking how important you are and know and have seen that you re nothing and know this is true. You only think you have power, but the God of Heaven trumps your little pissant god every single time.

Why do people fear them?

Anonymous Its Hammer Time April 12, 2013 11:26 AM  

In other news, gold just dropped below 1500.

Anonymous ODG April 12, 2013 11:38 AM  

Paper gold did. I wonder what the physical stuff is going for at the corner jewelry store?

Blogger BetaMax April 12, 2013 12:24 PM  

ODG - "i wonder what the physical stuff is going for at the corner jewelry store".

I own a coin store, and it has been very odd. Paper gold is dropping fast, but physical gold (and especially silver) has been very hard to get. We used to be able to get silver junk at 3% (wholesale) and lately we have seen 9.5% to 12% (wholesale).

But that may just be our location (northern U.S.).

Anonymous Jack Amok April 12, 2013 12:29 PM  

Why? Because they are desperate. They know that the alternative is either default and a short but savage depression that will absolutely ruin most of the world's wealthy and powerful or the collapse of the global financial system and quite likely a fair amount of the various political structures as well.

Rumsfeld talked about "Dead-enders" in Bagdad, the Baathists who couldn't see any desirable place for them in a post-Saddam Iraq. We've got the same sort of desperate, cornered rats in the financial sector.

So where is their Sadr City? Their Fallujah?

Blogger Nate April 12, 2013 12:39 PM  

Ok kids.

My response is up.

You want to know where Hyper inflation comes from?

Buckle the hell up dorothy. Kansas is going bye bye.

Blogger Nate April 12, 2013 12:48 PM  

"Let's try it this way. Do you agree that shutting down the Federal Reserve and forcing a default of all its credit would be deflationary?"

My response is up mate.

Enjoy.

Blogger Nate April 12, 2013 1:16 PM  

wow... epic formatting issues. My apologies. I think its all worked out at this point.

Anonymous DonReynolds April 12, 2013 2:02 PM  

Ms Rinehart is not being very honest. It was explicitly and publicly stated that the purpose of the Federal Reserve after WWII was to artifically keep interest rates low in order to manage the war debt, which included the ability to control consumer finance. Admit it? Heck, they were proud of it.

I expect we will see a change in public policy regarding who holds the national debt. Right now, the only entities that are required to hold Federal debt are the member banks of the Federal Reserve. I think you may see a proposal to require IRAs, 401, Keogh plans, and public employee retirement plans to invest half (or all) of these dollars in Treasury bills. This may wait until the foreign markets refuse to hold US debt. A scuffle with North Korea or siding with Japan against China may just hasten that day. I do not see much call for consumer credit controls just yet since they are allowed to charge 22 to 30 percent on credit cards and the Feds are slowly becoming the only player in the mortgage industry. (No need for consumer credit controls until they decide to deal with the high interest rates, which will happen when the public balks at paying it. The consumer economy is too important to kiss off.)

As central banks flood the market with cheap currency to fight the trade and currency wars with foreigners, a certain amount of inflation is inevitable (the prices of foreign goods will necessarily rise). Since part of the interest rate charged includes the inflation expectation, it becomes nearly impossible to hold down the interest rate when these same policies trigger more inflation! Everyone knows this already, so I expect the gap to become wider between the regulated and unregulated interest rates and many people now in the stock and bond market to be forced (required) to hold all or some of these funds in the form of Treasury bills. This will only buy them more time to continue the insane monetary and fiscal policies. At some point, the horse simply will not be ABLE to drink any more water.

Blogger Nate April 12, 2013 2:16 PM  

"At some point, the horse simply will not be ABLE to drink any more water."

No.

At some point the horse will refuse to drink that water... and go drink from another well.

Anonymous rycamor April 12, 2013 3:35 PM  

I don't know what everyone is complaining about here. I am reliably informed by one of my liberal Christian acquaintances that sure, there are no quick fixes, but we're headed in the right direction. And look! Economic data shows that many of the fundamentals are sound. So enough with the sky is falling. Go ye forth, borrow and spend!

Anonymous Boetain April 12, 2013 3:39 PM  

Dr. Doom:
You are ignorant regarding industrial production. Lots of people like you panic that the US doesn't produce anything tangible. I can only assume that those people live in big cities. Since big cities have internets, maybe these ignorant people can type "industrial production by country" into a search engine and get edumacated.

Anonymous Vetinari April 13, 2013 12:33 AM  

Savers are not and never were the backbone of the economy.

Imagine people stuffed their savings into their mattress. These people are savers. How do they benefit the economy? They do not.

Its not the saving that matters, but what you do with the money that matters. In other words, investment. And investment . . . is mostly financed by debt. With credit money, created by banks.

People take the accounting identity, Savings = Investment, and assume that trying to increase savings will increase investment, when the causality is the other way around.

Blogger Nate April 13, 2013 8:51 AM  

"Savers are not and never were the backbone of the economy."

Someone obviously hasn't been paying attention.

Anonymous rycamor April 13, 2013 11:55 AM  

Those with no potential can do nothing when the right time comes. That's in the positive and the negative. Savings is a massive buffer zone for an economy. The more savings, the more shock-absorptive it can be. And the better it can respond to opportunity when presented.

Is that not one of the most simple concepts to grasp? This has been clear to me even since my econ-illiterate days (never cracked a book on economics until the past 4 years).

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