Mike Shedlock (“Mish” as he is known to all) has written an excellent piece on the deflation-inflation debate, focusing on the Achilles Heel of the latter–the fact that it is based on the belief that we live in a “fractional reserve banking” monetary system. He offered to let me cross-post here, and I’ve reproduced it in its entirety below (there’s only one point I’m not sure on–the comment that there are no reserve requirements for savings accounts. From my reading of the footnotes to Table 12 in this Federal Reserve paper, that’s true of corporate accounts but not individual ones).
Also, there is an excellent article in the Guardian “The global economy’s decade of debt-fuelled boom and bust” by Larry Elliott (reproduced in the Fairfax press) that puts the debt-deflation and deleveraging case very well. Do read it.
And now, over to Mish!
Fictional Reserve Lending And The Myth Of Excess Reserves
In A Case for the Inflation Camp Robert P. Murphy asks When Will the Inflation Genie Get Out of the Bottle? Murphy’s concern is over “excess reserves”.
My reason for expecting large-scale price inflation is fairly straightforward: I see no coherent strategy for Bernanke to remove the excess reserves from the banking system. …
After reviewing the evidence and the theories offered by the two camps, I still believe that Bernanke’s unprecedented infusions of new reserves will lead to rapid price increases. These increases may not show up in the price of US financial assets, but they will rear their ugly heads at the gas pump and grocery checkout. Moreover, I think the genie may already be slipping out of the bottle. His escape will only be hastened once the year-over-year CPI figures show moderate inflation.
Steve Saville’s Concern Over Excess Reserve
Steve Saville expresses his concern over excess reserves in Bank Reserves and Inflation.
The reason that bank reserves aren’t added to the money supply is that they do not constitute money available to be spent within the economy; rather, they constitute money that could be loaned into the economy or used to support additional bank lending in the future.
Bank lending in the US has declined on a year-over-year basis, so we know that the spectacular increase in reserves has not YET contributed to monetary inflation.
If the private banks were to join the inflation party then the risk of hyperinflation would greatly increase, and hyperinflation — leading to what Mises called a “crack-up boom” — would be the worst of all possible outcomes. In particular, it would be an order of magnitude worse than the deflation that many people still seem to be worried about.
So, let’s hope that the banks don’t start lending out their excess reserves. The situation is bad enough already.
Gary North’s Concern Over Excess Reserves
Inquiring minds note Gary North’s concern over excess reserves in The Federal Reserve’s Self-Imposed Dilemma.
The Federal Reserve System faces a dilemma of its own creation: the doubling of the monetary base.
The only thing that is keeping this from creating mass inflation is the decision of commercial bankers to deposit the bulk of this increase with the Federal Reserve. The banks are not lending out this money. Neither is the FED. This money does not legally belong to the FED.
AN EASY SOLUTION WITH DISASTROUS CONSEQUENCES
There is an easy solution to this problem. The Federal Reserve knows exactly what the solution is. Nobody mentions it. The suggestion that the Federal Reserve would attempt it would probably bust the bond market. The Federal Reserve would announce that, from this point on, all money deposited by banks as excess reserves will be charged a storage fee. This fee could be 2%.
Not only would banks not make any interest on the money deposited with the Federal Reserve, they would begin suffering a loss of 2% per annum on the money held as excess reserves. …
Lots of Concern Over Excess Reserves
That’s a lot of concern over excess reserves. And if I looked around, I am quite sure I can find even more concern over excess reserves.
Here is a current chart that shows what everyone is concerned about.
Reserve Balances with Federal Reserve Banks
click on chart for sharper image
Money Multiplier Theory
The chart shows an unprecedented amount of excess reserves, almost $1.2 trillion.
According to Money Multiplier Theory (MMT) and Fractional Reserve Lending, this amount may be lent out as much as 10 times over and when it does, massive inflation will result.
Money Multiplier Theory Is Wrong
The above hypotheses regarding “Excess Reserves” are wrong for five reasons.
1) Lending comes first and what little reserves there are (if any) come later.
2) There really are no excess reserves.
3) Not only are there no excess reserves, there are essentially no reserves to speak of at all. Indeed, bank reserves are completely “fictional”.
4) Banks are capital constrained not reserve constrained.
5) Banks aren’t lending because there are few credit worthy borrowers worth the risk.
Let’s explore each of those points in depth.
1: Lending Comes First, Reserves Second
Australian economist Steve Keen has made a strong case that lending comes first and reserves later in Roving Cavaliers of Credit. I discussed that at length in Fiat World Mathematical Model.
That point alone should seal the hash of the debate but it keeps coming up over and over. So let’s try one more time.
Inquiring minds are reading BIS Working Papers No 292, Unconventional monetary policies: an appraisal.
Note: The above link is a lengthy and complex read, recommended only for those with a good understanding of monetary issues. It is not light reading.
The article addresses two fallacies
Proposition #1: an expansion of bank reserves endows banks with additional resources to extend loans
Proposition #2: There is something uniquely inflationary about bank reserves financing
From the article….
The underlying premise of the first proposition is that bank reserves are needed for banks to make loans. An extreme version of this view is the text-book notion of a stable money multiplier.
In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans.
The main exogenous constraint on the expansion of credit is minimum capital requirements.
A striking recent illustration of the tenuous link between excess reserves and bank lending is the experience during the Bank of Japan’s “quantitative easing” policy in 2001-2006.
Japan’s Quantitative Easing Experiment
click on chart for sharper image
Despite significant expansions in excess reserve balances, and the associated increase in base money, during the zero-interest rate policy, lending in the Japanese banking system did not increase robustly (Figure 4).
Is financing with bank reserves uniquely inflationary?
If bank reserves do not contribute to additional lending and are close substitutes for short-term government debt, it is hard to see what the origin of the additional inflationary effects could be.
There is much additional discussion in the article but it is clear that MMT theory as espoused by Murphy, Saville, North and others did not happen in Japan nor is there any evidence of it happening in the US, nor is there a sound theoretical basis for it.
In fiat based credit systems, lending comes first, reserves come second, and extra reserves do nothing much except pay banks to sit in cash in cases where interest is paid on excess reserves.
I will touch more on reserves coming after lending in the discussion of points 3 and 4 below.
2: There Are No Excess Reserves
Let’s now turn our attention to the idea there are excess reserves. To do that, let’s consider nonperforming loans, total loans and leases, and allowances for loan and lease losses.
Total Nonperforming Loans
click on chart for sharper image
The above chart is from St. Louis Fed based on Reports of Condition and Income for All Insured U.S. Commercial Banks.
Percentage of nonperforming loans equals total nonperforming loans divided by total loans. Nonperforming loans are those loans that bank managers classify as 90-days or more past due or nonaccrual in the call report.
Nonperforming loans have soared to a record five percent for this series.
The above chart just gives a percent. We need to quantify the amount. The following chart will help do just that.
Total Loans and Leases of Commercial Banks
The above chart of total loans and leases shows a total of nearly $7 trillion, of which five percent is nonperforming. In other words there is about $350 billion of nonperforming loans on the books of banks (that are admitted to).
That last part about admitted to is crucial. Nonperforming loans do not include off balance sheet garbage, various swaps with the Fed, or ridiculous mark-to-fantasy valuations of assets held on the books.
Total Loans and Leases of Commercial Banks Percentage Change
On a percentage basis the drop in loans and leases is unprecedented.
But wait. Banks might have made provisions for those loan losses already, might they not? Well … in a single word, No (as the following chart shows)
Assets at Banks whose ALLL exceeds their Nonperforming Loans
The above chart courtesy of the St. Louis Fed.
Because allowances for loan losses are a direct hit to earnings, and because allowances are at ridiculously low levels, bank earnings (and capitalization ratios) are wildly over-stated.
Excess Reserves? You still think so?
3: Bank reserves are “Fictional”, there are essentially no reserves at all.
To see if we can prove this statement we can look at total lending vs. base money supply and M2.
Karl Denninger at Market Ticker has a nice chart of total lending based on Federal Reserve Z.1 Flow of Funds data.
Cumulative Debt
click on chart for sharper image
Base Money Supply
Note the rampant increase in base money which is the source of those so-called excess reserves.
Let’s do a little math.
There is 2,000 billion base money.
There is 52,000 billion lending.
The ratio of base money to lending is 3.8%
Prior to the ramp in base money (which by the way was the Fed’s feeble attempt to supply reserves after the fact), there was $800 billion base money supporting $52,000 billion in lending. Not too long ago, the ratio of base money to lending was a mere 1.5%.
Want to use M2 instead?
M2 Money Supply
click on chart for sharper image
Using M2 as money supply available for lending makes the ratios better. However, the largest component of M2 is savings accounts at almost $5 trillion of that $8.5 trillion M2.
However, money in savings accounts is not there. Reserve requirements on savings accounts are zero. It has all been lent out. Moreover, Greenspan authorized sweeps in 1994 to specifically allow banks to “sweep excess reserves” from checking accounts into savings accounts so the money could be lent out.
There is no money in savings accounts or checking accounts other than an electronic mark that says there is. Both contain money only in theory. That money that has already been lent out and redeposited, over and over and over.
Reserves? There are no reserves. Indeed, reserves are best thought of as negative.
Fractional Reserve Lending is really Fictional Reserve Lending.
4: Banks are capital constrained not reserve constrained
Number four gets down to the heart of the matter. Banks are not lending because they are capital constrained, not because of any reserve issues.
The Bank of International Settlements (BIS) sets standards that pertain to asset quality and required capital that the banks must hold.
The first document is a whopping 284 pages long while the second is 150 pages long. I do not advise reading either. I include them for completeness.
Capital requirements
Wikipedia explains Capital Requirements and Capital Adequacy Ratio in brief form but the articles need work. Nonetheless, they seem to be a reasonable although complex overview.
From Wikipedia: The capital ratio is the percentage of a bank’s capital to its risk-weighted assets. Weights are defined by risk-sensitivity ratios whose calculation is dictated under the relevant Accord.
Here is a chart on risk weightings. Remember what happened to those AAA rated loans?
Risk Weightings
Fed Can Provide Liquidity Not Capital
Flashback March 01, 2008: Poole, Paulson, Bernanke on Bailouts and Bank Failures
Fed Governor William Poole on Moral Hazards:
I am more skeptical of the financial strength of the GSEs, and believe that we could see substantial problems in that sector. According to the S&P Case-Shiller home value data released earlier this week, as of December 2007 average prices had declined by 15 percent or more over the past 12 months in Phoenix, San Diego, Miami and Las Vegas. We can add Detroit to the danger list as the home price index for that city is down by almost 19 percent over the 24 months ending December 2007. With house prices falling significantly in a number of large markets, many prime mortgages issued a few years ago with a loan-to-value ratio of 80 percent may now have relatively little homeowner equity, which increases the probability of default and amount of loss in event of default.
As I have emphasized before, the Federal Reserve can deal with liquidity pressures but cannot deal with solvency issues. I do not have any information on the GSEs that the market does not also have. Nevertheless, in assessing the risk of further credit disruptions this year, I would put the GSEs at the top of my list of sources of potentially serious problems. If those problems were realized, they would be a direct result of moral hazard inherent in the current structure of the GSEs.
First Nationalized Bank Of Fannie
Poole hit the nail on the head. Fannie Mae and Freddie Mac blew up and were nationalized. They did not run into reserve constraints. They ran smack up against capital constraints.
Also note that the Fed did not bail them out. Taxpayers did, authorized by Congress. The losses might hit $400 billion.
Fannie Mae is not a bank, but for all practical purposes it may as well be. Much lending growth comes from the GSEs. Money (credit really), is borrowed into existence, and redeposited elsewhere, and lent out over and over again.
When Fannie Mae and Freddie Mac ran into problems, capital was provided after the fact, not by the Fed but by taxpayers. The same applies to Citigroup, Bank of America, Wells Fargo on down the line.
In the March 2008 Poole post, I also commented on Bernanke.
Bernanke Expects Bank Failures
Testifying before Congress on Thursday, Bernanke stated Banks should seek more capital.
“Among the largest banks, the capital ratios remain good and I don’t anticipate any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system,” he said in response to a question during semi-annual congressional testimony.
“They have already sought something of the order of $75 billion of capital in the last quarter. I would like to see them get more,” Bernanke said.
“They have enough now certainly to remain solvent and remain … well above their minimum capital levels. But I am concerned that banks will be pulling back and not making new loans and providing the credit which is the lifeblood of the economy. In order to be able to do that … in some cases at least, they need to get more capital,” Bernanke added.
Bernanke certainly blew it about the large banks being well capitalized. However, he was certainly correct with “In order to be able to [lend] … in some cases at least, they need to get more capital”
Note that this was a capital concern not a reserve concern.
Capital Is The Problem At Virtually All Banks
Flash forward August 19, 2009: Emails from a Bank Owner regarding FDIC and Under-Capitalized Banks.
Here is an interesting followup email from ABO [a Bank Owner and CEO] regarding bank capital.
ABO Writes:
I talked to a friend this morning who is retired from both the Federal Reserve of Kansas City and RSM McGladrey. He now does consulting work with the FDIC, due diligence and other regulatory work. He said the picture he is seeing is worse than at any time in his life and CAPITAL is the problem with virtually all banks.
Inquiring minds will also be interested in an August 24, 2009 post Critically Under-Capitalized Banks Direct Result of “Wonderful Chain of Stupidity”. That post also shares some emails with “ABO” including …
Hiding The Losses
ABO Writes:
Take a look at how the FDIC is selling failed banks. It is a little different than in the past. The FDIC is using a loss sharing agreement that is usually around 80-20 and has certain guidelines on timing of the losses. I would guess that the losses on the failed banks are dragged into the future somewhat rather than being recognized at the time the bank is closed. This method would be less of an immediate hit to the fund and would probably create a contingent liability rather than a direct one. The banks that agree to this loss sharing plan are relying on the promise of the FDIC to make good on future guarantees for losses. The losses are not backed by the full faith of the government.
The Fed and FDIC always want to delay addressing the problems, hoping they will go away. Such structural problems seldom do.
Amazingly Financial Group was considered “well capitalized” right up to the brink of failure. When the bank did fail, the hit to FDIC was not immediately taken but stretched into the future.
The WSJ article notes ‘There are 1,400 banks that own mortgage-backed securities that aren’t backed by government-related entities such as Fannie Mae and Freddie Mac.” What we don’t know is how many of those banks are levered up enough in garbage mortgages to fail.
Note too that those garbage trust-preferred securities problems are on top of the widely expected fallout from commercial real estate problems affecting small to medium-sized regional banks. Thus, banking woes are much deeper in many areas than either the FDIC or Fed is admitting.
FDIC Allows Banks To Hide Insufficient Capital
Let’s flash forward once again.
Dateline December 15, 2009: FDIC Approves Giving Banks Reprieve From Capital Requirements
The Federal Deposit Insurance Corp. gave banks including Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. a reprieve of at least six months from raising capital to support billions of dollars of securities the firms will be adding to their balance sheets.
Bank regulators including the FDIC and Federal Reserve want to permit a phase-in of capital requirements that rise starting next month under a change approved by the Financial Accounting Standards Board. The rule, passed in May, eliminates some off- balance-sheet trusts, forcing banks to put billions of dollars of assets and liabilities on their books.
Executives from Citigroup, JPMorgan, Bank of America, Wells Fargo & Co., Capital One Financial Corp. and the American Securitization Forum met FDIC officials Dec. 2 to discuss capital requirements related to the FASB measure.
The executives proposed that “the transition period should extend beyond 2010 to a point in the economy where unemployment is lower and issuers are less capital-restrained from growing their balance sheet and providing credit,” according to a paper the ASF presented the FDIC.
Citigroup suggested three years to offset assets and liabilities brought onto balance sheets, Chief Financial Officer John Gerspach said in an Oct. 15 letter to regulators. Requiring banks to “assume the risk-based capital effects immediately, or even over one year, is an undeniably severe penalty,” he wrote.
Fictional Capital
Not only are there no reserves, the above should prove without a doubt there is insufficient capital for banks to lend.
Amazingly, the Fed and banks have the gall to proclaim banks are well capitalized.
Global Implications Of Stronger Capital Rules From Basel
Just to prove capital is not just a US concern, please consider Japan Banks Fall on Stronger Capital Rules From Basel.
Global regulators have been wrestling with plans to tighten bank supervision following the worst economic crisis since World War II. The Basel Committee said yesterday banks’ core capital should exclude stock or instruments that may require lenders to make payments to third parties, as these could reduce reserves needed for meeting losses.
“The tightening of Tier 1 quality standards is overall negative for the Japanese banks because they have weak Tier 1 quality,” said Stephen Church, a research partner at Japaninvest KK, an independent research firm, in Tokyo. “The stock market is differentiating between those banks which have stronger Tier 1 and those which are weaker.”
The committee also said banks should have an “appropriate” period of time to replace such instruments.
Hopefully that proves beyond a shadow of a doubt that banks are capital restricted. Thus, even if banks had excess reserves (which they clearly don’t), banks would not be lending anyway.
Of course, the idea that banks need reserves in the first place is fallacious.
Let’s tie a bow on this five point package with …
5: Banks aren’t lending because there are few credit worthy borrowers worth the risk.
Even if banks had the capital to dramatically increase lending (which they don’t), banks would still have to make the determination they want to lend.
Backdrop Banks Face
- Yahoo! reports Credit card chargeoffs rise in November
- Bloomberg reports Seven U.S. Banks Are Seized, Raising Year’s Failure Toll to 140
- Bloomberg reports Banks Take Losses on Short Sales as Foreclosures Soar.
- Bloomberg reports ‘Shadow Inventory’ of U.S. Homes Climbs.
- Yahoo!Finance reports Commercial Real Estate Loans A Growing Problem For Banks
- CNNMoney Reports Bernanke: Weak recovery ahead
If you were a bank would you be anxious to lend into that? If you were a business would you want to expand into that?
Please consider the latest Fed Senior Loan Survey.
Demand for C&I loans from small firms
Lending Standards For Small Firms
85.5% of banks responding to the survey have lending standards that basically remained the same yet 44.6% of banks report moderately weaker demand for loans, with only 8.9% reporting moderately stronger demand for loans.
In spite of all the claims that banks are not willing to lend, the data suggests that the predominant factor is there are fewer businesses wanting loans.
Arguably (but there is no way to tell from the tables) fewer still credit worthy businesses want loans.
Those who want banks to increase lending, I have to ask “For What? To Who? At What Rate?”
There are actually plenty of reasons for banks not wanting such as rising unemployment, rising taxes, uncertainty over health care costs, proposed cap-and-trade costs, increasing consumer frugality, rampant overcapacity, and boomer demographics.
One Unaddressed Point
Gary North proposes Bernanke can force banks to lend. Really? When Bernanke knows banks are capital constrained? When it is obvious that it would be suicidal?
Bear in mind that Bernanke has recently talked about upping the interest on reserves, not making it negative. Moreover, by paying interest on reserves, the Fed can very slowly recapitalize banks over time while simultaneously and subtly suggesting that banks not take excess risks.
With that in mind, let’s try and stay within the solar system of 99.9% probability rather than the universe of theoretically possible negative 2% rates on reserves.
Excess Reserve Recap
1) Lending comes first and what little reserves there are (if any) come later.
2) There really are no excess reserves.
3) Not only are there no excess reserves, there are essentially no reserves to speak of at all. Indeed, bank reserves are completely “fictional”.
4) Banks are capital constrained not reserve constrained.
5) Banks aren’t lending because there are few credit worthy borrowers worth the risk.
Reserves? There are no reserves. Indeed, reserves are best thought of as negative. Instead, in cases of “too big to fail”, capital (not reserves), is supplied after the fact by taxpayers (not the Fed).
Thus, concern that excess reserves will lead to lending and inflation is totally unfounded in theory and practice.
Fractional Reserve Lending is really Fictional Reserve Lending. In practice, the major constraints to lending are insufficient capital and willingness of credit worthy borrowers to seek loans.
“Ramanan/Superpoincare”
Obviously I didn’t precis the “Automatic Earth” article well ( and only attempted to do so at all because everything in the site was slow whilst everyone was off eating Christmas lunch etc) because we are at odds as to the points “they” are making, which I found interesting.
That point was not that “..government issuing less debt than the deficit..” was an issue and nor I would guess, is it likely that “…probably there is some issue at the data collection stage..” .
Maybe the more end game point of what Sprott & Franklin are getting at through their apparently detailed study, is that the Fed is “….faking the Treasury’s ability to attract outside capital.” And the final sentence of the excerpt below.
“Talking about US Treasuries, Canadian investor Eric Sprott has been trying to figure out who bought them in 2009. In a report entitled Is it all just a Ponzi scheme?, Sprott and David Franklin suggest that it’s impossible to find who was the second largest buyer. Of the $1.885 trillion dollars in public debt the US added in 2009, $704 billion (annualized) was bought by “Other Investors”, a collection of buyers they find defined in the Federal Reserve Flow of Funds Report as the “Household Sector”. the $704 billion is 35 times more than this sector bought in the prior year, 2008, according to Sprott and Franklin. They phrase it like this:
Amazingly, we discovered that the Household Sector is actually just a catch-all category. It represents the buyers left over who can’t be slotted into the other group headings. For most categories of financial assets and liabilities, the values for the Household Sector are calculated as residuals. That is, amounts held or owed by the other sectors are subtracted from known totals, and the remainders are assumed to be the amounts held or owed by the Household Sector. To quote directly from the Flow of Funds Guide,
“For example, the amounts of Treasury securities held by all other sectors, obtained from asset data reported by the companies or institutions themselves, are subtracted from total Treasury securities outstanding, obtained from the Monthly Treasury Statement of Receipts and Outlays of the United States Government and the balance is assigned to the household sector.”
So to answer the question – who is the Household Sector? They are a PHANTOM. They don’t exist. They merely serve to balance the ledger in the Federal Reserve’s Flow of Funds report.
Our concern now is that this is all starting to resemble one giant Ponzi scheme. We all know that the Fed has been active in the market for T-bills. [..] they bought almost 50% of the new Treasury issues in Q2 and almost 30% in Q3. It serves to remember that the whole point of selling new US Treasury bonds is to attract outside capital to finance deficits or to pay off existing debts that are maturing. We are now in a situation, however, where the Fed is printing dollars to buy Treasuries as a means of faking the Treasury’s ability to attract outside capital. If our research proves anything, it’s that the regular buyers of US debt are no longer buying, and it amazes us that the US can successfully issue a record number Treasuries in this environment without the slightest hiccup in the market.
Translation: the Sprott report accuses the US Treasury and/or the Fed of buying US treasuries themselves, in much larger numbers than they acknowledge.”
Al49er,
I understood the point you are trying to make. However this is a huge accusation – you are accusing the biggest financial institution of the world of a scam. The accusation is that of monetization without notifying the public. That is a big claim. The only “proof” you have (the Sprott report) is the huge increase in the household holding of treasuries seems incorrect. What if the households really purchased them ?
Fair enough “Ramanan/S” I accept that you understand ( and disagree with ) the proposition.
I will conclude and await the proof ( one way or another ) of time and outrcome just reiterating, it is not MY accusation ( I don’t have the knowledge and haven’t done the study), I just felt that the authors ( of the Sprott report) put an interesting and well argued proposition worth a bit of( further) exposure here , if not in ‘peak time’, certainly during a lull.
No doubt ‘ak’ , ‘btb’ and others will return soon to get back into the original thinking.
” I think Mish’s argument gives grounds for arguing the reserves are compromised by the overstated value of bank assets elsewhere, not that there are no reserves at all”
just trying to get my head around this
so when banks go on assett grabbing exercises which create loans, they end up as deposits in the acounts of their new or existing cusomers. if they sell or create too maany loans, the increases in deposits will mean their deposits to reserves ratio will be compromised, and given the potential inelasticity of demand for reserves, if the interbank market cannot provide the required reserves they have to go to the fed in order to comply.
and given that the fed doesnt pay interest on reserves, and there is a two week lag in banks having to account for any deficiency, means that the fed funds rate amounts to a tax on reserves, which means there is considerable incentive in the whole system for banks to play roulette with their reserve requirment. sell loans first and worry about any reserve requirment later
on the right track?
just a further thought on the matter,
at the level of an individual bank
even though this loan creation can lead to a system wide increase in the deposit base, its very difficult for individual banks to predict the effect of this on their deposit base, thus they may miss their reserve requirment target.
Best of the Season to everyone.
This is slightly off the current topic but there is a good article (front page) in the Sunday Telegraph today about debt and the heavily indebted Australian Economy.
Steve gets an honourable mention and is well quoted. It was noted before that the business editor, Nick Gardner understands the issues and its good to see acurate publishing of steve’s position and data.
There is also a quote from Shane Oliver about debt being our achilles heel.
Maybe he is contemplating coming back over to the ‘dark side’ as he was a property and debt bear about 12 months ago.
Well done Steve, even in the middle of the holiday season you are hard at it.
Yes, good to see the excess debt message getting some coverage. The version I saw quoted “Mortgages account for almost 90 per cent of annual GDP, up from 17 per cent in 1990″. How are mortgages accounted for in GDP? Is it the capital amount + the interest payments. If the capital amount is included, seems strange as its a one of item and represents “money” that is essentially static and unproductive.
That’s just awkward English Herbert. The expression means a ratio of debt (a stock) to GDP (a flow). Comparisons like that are fine–notwithstanding ignorant comments from some market economists to the contrary–because they tell you how many years of GDP are needed to pay debt down to zero.
It would on the other hand be a mistake to add debt to GDP: then what you have to do is add the change in debt (a flow) to GDP (also a flow). The main reason why I identified this crisis and 99% of economists were totally unaware of it is that my analysis focuses on the role of debt (and the change in debt) on aggregate demand, whereas conventional neoclassical economics ignores private debt.
al49er Steve and All,
Best of the season to everyone.
al49er, I am certain that one facet of the quid pro quo’s of all the opaque and smelly dealings between Wall St banks, The Fed and US treasury are complicit agreements to manipulate what essentially is the US Bond market- all under the auspices of “The President’s Working Group on Financial Markets” or the PPT.
Any body who believes this fraud is not possible simply does not understand the dire state of US finances- as an example look at how the US FASB was rolled to not enforce mark to market accounting. Also the non reporting of M3.When it comes to self preservation the US will not shy away from fraudulent acts. You will also note that there has been no indictments whatsoever concerning dodgy mortgage issuance and the even more dodgy derivatives they have spawned.It is not rocket science as to why.
It would be a very easy arrangement that would allow the US Fed to buy UST’s through it’s Primary Brokers and conceal the purchase through dodgy accounting.It would seem that Sprott and other are onto it.There is also the perspective that after the turmoil of 08/09 markets just don’t want to know about such goings on in any case.
@Ramanan/superpoincare 53
“I understood the point you are trying to make. However this is a huge accusation – you are accusing the biggest financial institution of the world of a scam.”
Precisely but this cabal is not just comprised of financial institutions. Take a look at Argentina’s economic collapse in 2001 which wiped out the middle class and raise the poverty level to over 50 percent. This could be our future.
http://www.youtube.com/watch?v=rH6_i8zuffs
“The accusation is that of monetization without notifying the public. That is a big claim. The only “proof” you have (the Sprott report) is the huge increase in the household holding of treasuries seems incorrect. What if the households really purchased them?”
Talking a figure of 100 million American households (3:1 per population). Each household would had to have purchased US$7,040 in treasuries. This is at the same time when each average household (3:1 per population) would have debt of approximately US$100,000.
Of cause there no direct proof because any real investigation to ascertain the proof is blocked. Taking one example which is to audit the Fed (HR1207) and Ben Bernanke’s defense against this action.
http://www.youtube.com/watch?v=HycCS0ONfn
It seems that Barack Obama would like us to take the blue pill and have us all go back to sleep.
Alan Gresley,
Hysteria creation! Argentina’s currency was not sovereign. T
The net worth of households and profit organizations is around $53T in the US. http://www.federalreserve.gov/releases/z1/Current/z1.pdf
So $100,000 debt per household does not convey enough.
Maybe they just sold off some equity and bought the Treasuries. Note the $700B is annualized so for this year it is actually 3/4th of that since the latest data is till Q3. There is something funny about the tables F.209 and L.209 but the latter (levels as opposed to flows) gives a picture which seems OK to me.
I don’t think they are so silly that they do a monetization without notifying the public or worse cooking up balance sheet numbers. At any rate, its completely inconsequential to me. I understand there are a lot of frauds there – Government Sachs is running the government etc… a lot happened unnoticed with AIG and those are more important stuff.
M3 has no consequence as hence the Fed stopped publishing it. I feel I am talking to a bunch of Austrians.
@Christopher Dobbie 24,
The maker of Zeitguist, Paul Joseph makes documentary about conspiracy theories.
http://www.youtube.com/watch?v=4PpMdTmVMpo
Getting pass the parts that are truth, fiction or somewhere in between, the most startling part of this segment of the original Zeitgeist documentary are Paul Joseph’s words.
“The most incredible aspect of all, these totalitarianism elements will not be forced upon the people, the people will demand them.”
If we are to follow what happened in Argentina in 2001 (see my previous comment 61), do you think that we would want to be kept safe from the mobs in the streets? Would we demand totalitarianism elements to arise?
Steve Keen says in a video featured on his latest blog, “Interview on Engineer.net” that the Great Depression resulted in the rise of Fascist regimes that led to WW2. I agree with Steve Keen’s assessment of economics, politics and history of this period of time.
My question is, is history repeating itself but now on a far larger scale? The reason that I contemplate poising such a question is the fact that some of those who are in power now (some discretely) are descendants from those who were in power 80 years ago.
“Precisely but this cabal is not just comprised of financial institutions. Take a look at Argentina’s economic collapse in 2001 which wiped out the middle class and raise the poverty level to over 50 percent. This could be our future”
hi alan,
understand your concerns but the argies are a bad example.
they had a currency peg to the US dollar which brought them unstuck, because they didnt have the reserves to defend it.
funnily enough dubai has the same issue, but UAE reserves are more than enough to defend the peg for the time being.
china’s in the same boat. it will be interesting to see how long these pegs last, whether changes in global trade flows especially with the US will ultimately destroy these mechanisms
the main thing is that the argies got rid of the peg , gave the imf the two fingered salute, and undertook fiscal expansion. capital inflows dried up for a while, but eventually there economy picked up as a consequence which again made them a viable proposition in terms of foreign perceptions of their spending power.
@Ramanan/superpoincare 62,
“Hysteria creation! Argentina’s currency was not sovereign.”
Neither were the owners of the Argentinian economy sovereign. If you watch part 2, 3 and 4 of the documentary, you will notice that this leads back to Wall Street. In this aspect, us first world nations face the same challenges. We are losing our sovereignty to an international group of banksters.
“The net worth of households and profit organizations is around $53T in the US.”
The is according to the subjective worth data generated by the Fed on opaque analysis base on false economic data.
“So $100,000 debt per household does not convey enough.”
Enough of what? Are you saying this figure should be upwards? I base this debt per house on this. Total household debt US10T divided by 300 million people equals US$33.333. Using a ratio of 3 person per household this calculates to the value of US$100,000 per household. The average yearly interest alone could be 10 percent which equal US$10,000 per household which is more than US$7,040 in US treasuries. You can hide many fine details by using averages.
“Maybe they just sold off some equity and bought the Treasuries.”
What percentage of the population of the US has the spare cash to do this?
“I don’t think they are so silly that they do a monetization without notifying the public or worse cooking up balance sheet numbers.”
If they were committing fraud, then they would want to cook the balance sheets.
“At any rate, its completely inconsequential to me. I understand there are a lot of frauds there – Government Sachs is running the government etc… a lot happened unnoticed with AIG and those are more important stuff.”
How many Government Sachs employees have or now work for the US Government or the Fed?
“I feel I am talking to a bunch of Austrians.”
I only knew of Austrians economics last year (as well as those rumors of sinister conspiracies). Over 20 years ago at the time when I thought we lived under a full reserve banking system, I knew that upon seeing the data of transfer of wealth from the poor to the wealthy for the period from the 1960s to the 1980s, that this form of capitalism was not sustainable since it was eating away at the base of the pyramid. Eventually the bottom layers and then the middle layers would fall and this would result in the whole system collapsing like a house of cards.
I was being a realist and at this time I said to myself that I would not acquire debt since I saw the bankster as fraudulent gangsters.
Now I must go off and see what I can find in council roadside cleanups. Seeing what households throw away firsthand allows me to imagine how to release my potential of creating true wealth or saving. So far I may have saved the world US$100 million in web development cost for a period of maybe 10 years. Now my wealth creation potential could be over US$500 million dollars. In my time doing council roadside cleanups, I have seen imported goods of a value well into the millions. Some of the major items are furniture made out of chipboard, bedding material and cloths.
JKH @17 et al,
Mish is an interesting hybrid of austrian and post keynsian.
His evolution away from ther former and towards the latter is most interesting. I have tried to point out to him that loan losses can’t be absorbed by reserves to no avail.
Mish’s ideology is austrian, but his economic understanding is increasingly at odds with that school. It’ll be interesting to see how he reconcliles heart with head.
I predict that this moment of internal conflict will come when he has to admit to the objective reality of the paradox of thrift, which is the only possible endpoint of the line of economic reasoning he has embarked upon.
Scepticus,
If you go to Mish’s website – there is a petition for balancing budgets!!!
ramanan, yes there is – however he is the only prominent austrian type to deny the money multiplier.
he also agrees that loans create deposits, which will sooner or later lead him to question his austrian ideological beliefs.
I think the battle is already being fought in his mind – it is beginning to spill into his posts.
If what the conspiracy theorists say are true, then the infinitely powerful government would ensure they do not get airplay.
If they are wrong well that is probably why they exist.
Hi, My name is Davide and I’m new in this blog. Firstly, I’ll want to say that this blog is fantastic and I’m learning much things from Mr Keen and from other people who partecipate in the network. Secondly, I’ll want to excuse me for my bad english but I’m an italian student and I learned english only by reading academic papers.
Thirdly, I’ll want to raise a question about some results founded by Mr Keen in his academic reaserch. Mr Keen emphasizes, correctly, in his Goodwin-Minsky model the importance of debt and the role played by banks in cyclical process. But in his mathematical model the debt GDP ratio is positive! That is, the firms accumulate assets and the banks play no role in the process. This is the opposite of Minsky theory and results.
Welcome aboard David,
I think you are mis-reading the model somewhat: in my models I record debt as a positive quantity, so that when it is greater than zero then some entity (the firm sector) owes money to the banks.
In some runs of the Goodwin-Minsky model I do get negative debt levels, which means that firms accumulate financial resources and receive interest payments from the banks. But in general I get positive debt levels, and therefore firms having a liability to the banking sector. In the Circuit models, debt always remains positive and greater than the deposits of banks, in which case firms have a net liability to the banking sector. This is consistent with Minsky (and somewhat more importantly in this instance, Schumpeter).
All the best, Steve
PS Your English is excellent–far better than my (non-existent) Italian and the bare remnants of my schoolboy French
Thanks a lot Mr Keen for your reply.
I read some of your papers, but in the simulation models à la Goodwin-Minsky I have seen always a neagative debt gdp ratio. With the term simulation model I intend model not flow consistent such as Circuit Models. In these kind of models I see always a negative debt gdp ratio (for example in 1995 Journal of Post Keynesian model, in your PHD thesis posted on this blog, and 2003 paper “Big Government as an Accidental Controller in Minsky’s Financial”). If you have a more recent simulation model (not stock-flow consistent) with a positive debt GDP ratio, could you be so kind to suggest me the name of the paper? Thanks.
Hi David (#72), I think there’s still some mis-reading going no here, so I’ll send you a paper that’s a bit clearer via your email: the pre-Circuit models always had corporate debt as a positive sum when firms owed banks money, and a negative sum when banks owed firms. In the paper I’ll send you from Commerce, Complexity and Evolution–which used the same model as in the JPKE paper–I show that the (unstable for some parameter values) equilibrium debt to output ratio is +7.02% (page 97) while in the simulations of a breakdown from a different set of initial conditions, debt to output reaches +3.75 in the final cycle.
I’ll also put that paper up on the Research Tab here I haven’t had the time to organise all my papers yet and that tab is a bit out of date and incomplete!
Thanks Mr Keen! The model in this paper is different from the model appeared in 2003 (Big Government as an accidental controller in Minsky’s Financial Instability Hypothesis) where debt gdp ratio was negative. Infact I have founded Vissim files of 2003 paper which has a negative debt.
Another question: Could you be so kind to send me the parameters values (coefficients and initial values) used in the simulation reported in the paper which reproduce a positive debt? This is because now I’m excited and interested in reproducing the results in Vensim software!
re #74 Mish. Ah! So that’s where you got the negative from! Yes, in earlier papers I did that but I changed the convention very early on.
This paper has a table at the back that fully specifies the equations and the parameters and initial conditions used; and I’ll copy you some other work in my morning tomorrow.
Thanks Mr Keen. I’m reading this paper and I’ll wait other works tomorrow which explain the parameters used.