PG: NY Fed Pres "We Are Not Printing Money"

A brief writeup over at the Pragmatic Capitalist regarding the misunderstanding of Quantitative Easing and the distortion it is causing. The Fed President is correct - the Federal Reserve is not "printing money" and the quicker we help people understand this (note I am not saying the quicker we support the Fed....I don't) the better off we will be.

Scott Dauenhauer CFP, MSFP, AIF

PragCap: Understanding The Mechanics of a QE Transaction

Want to have your mind blown? The link above demonstrates how the Federal Reserve implements its policy of Quantitative Easing - it is not what those on TV lead you to believe (this is not a defense of Bernanke.....please don't misunderstand).

Here is an excerpt:

Before we begin, it’s important that investors understand exactly what “cash” is. “Cash” is simply a very liquid liability of the U.S. government. You can call it “cash”, Federal Reserve notes, whatever. But it is a liability of the U.S. government. Just like a 13 week treasury bill. What is the major distinction between “cash” and bills? Just the duration and amount of interest the two pay. Think of one like a checking account and the other like a savings account.

This is a crucial point that I think a lot of us are having trouble wrapping our heads around. In school we are taught that “cash” is its own unique asset class. But that’s not really true. “Cash” as it sits in your bank account is really just a very very liquid government liability. What is the difference between your checking and savings account? Do you classify them both as “cash”? Do you consider your savings accounts a slightly less liquid interest bearing form of the same thing a checking account is?

What is a treasury note account? It is a savings account with the government. So now you have to ask yourself why you think cash is so much different than a treasury note? What is the difference between your ETrade cash earning 0.1% and that t note earning 0.2%? NOTHING except the interest rate and the duration. You can’t use your 13 week bill to pay your taxes tomorrow, but that doesn’t mean it isn’t a slightly less liquid form of the exact same thing that we all refer to as “cash”. They are both govt liabilities and assets of yours.

When you own a t note you really just traded your “cash” for a slightly less liquid form of the same exact thing. If the Fed buys those t notes from you they give you back your cash minus the interest rate. That’s all there is to it. No change in the money supply. No change in anything except the rate of interest you were earning. If the government removes t notes then all they’re doing is altering the term structure of their liabilities. They’re not changing the AMOUNT of liabilities.

Scott Dauenhauer, CFP, MSFP, AIF

Stiglitz: Justice for Some

Some food for thought, hit the link above.

Scott Dauenhauer, CFP, MSFP, AIF

American is Not Greece: Why Glenn Beck and Most Economists/Politicians Are Wrong

"America is Greece" is the refrain you continue to hear from many politicians (particularly Republican). When searched on Google it comes up over 11,000 times. You also hear from the likes of Glenn Beck that if China stops buying our Treasury Bonds that in literally a few weeks the entire nation will collapse (kind of defeats the point of China's military....and ours I guess).

Is this hyperbole based on reality? Well, the answer is no, but there is some common sense that drives such rhetoric.

Before I go forward, let me just say that the more I learn about economics the less I feel I know. Having said that, I do know a few things.

First - the main point of Beck, Republicans and whomever is that America is spending too much - in this respect I think I can agree. I can also agree that, like Greece, we are likely to see riots in the streets if certain pension and health care benefits are cut. However, what Beck and others don't seem to understand is that the United States Government is nothing like Greece and WE DON'T NEED Chinese money to survive. In fact, interest rates don't HAVE to rise if the Chinese decide to get rid of their treasury bills.

The reality is that Greece is more akin to California than America. California cannot print its way out of budget problems because California can't issue its own currency. Greece doesn't issue its own currency anymore (they are on the EURO) and thus they can't print (read: devalue) their way out of there problems. The United States Government DOES NOT HAVE THIS PROBLEM. The U.S. can print as much money as it wants to pay off its debts. This means that it cannot outright default (they can, they just don't have too). If China stops buying our bonds, someone else will at either a higher interest rate or the Federal Reserve will buy them (please understand that this is not an endorsement of such policy, just the reality).

This doesn't mean that the actions of the Federal Reserve to deal with the very same issues that Greece has won't eventually harm us, I can assure it will. My point is that the America IS different because we have a different monetary regime.

Our current Federal Reserve leaders are leading us down the path of destruction, though they are of course being led by our politicians (don't be fooled by the last two elections - it really doesn't matter if its a Republican or a Democrat - neither can bring any kind of fiscal sanity about, nor do they want to....save just a few).

The Federal Reserve has embarked upon another round of Quantitative Easing - or printing money to buy assets. I do want to make it clear that while it appears the intention is to create inflation, I'm not positive it will. While it is true that the Fed literally pays for the Treasury Bonds with money that is created out of thin air, it is also true that this money doesn't actually stay in the system. If the Fed buys a Treasury bond and spends $1 billion the Treasury Bonds come onto the balance sheet of the Fed and stay there, the money goes to the people who sold the bond. The net change is that the Fed has $1 billion in bonds (of which interest is flowing to the Fed and is actually taken out of the system) and the entity who had the bond now has cash. There isn't any additional net assets in the system, the entity who had the bond now has cash (which could be used to buy more treasuries or other assets).

This is different than if the Federal Reserve called up the Mint and asked for $1 billion to be printed and then simply GAVE it to someone without receiving something in return. That would be pure money printing as the amount of cash actually in the system increased - that is potentially inflationary, but it isn't happening.

If you really want to research and understand our monetary system I suggest Austrian theory, reading Mike Shedlock and heading over to the Pragmatic Capitalist (he has some mind blowing stuff). I admit that my little explanation above likely places me in the category of Tim Allen's character on Home Improvement after trying to explain what his neighbor Wilson told him - but at least I'm willing to admit it.

Your Tim Allen Economist,

Scott Dauenhauer, CFP, MSFP, AIF

Humor Break: More Foreclosure Crisis Headlines from Charles Hugh Smith

This is just too funny!

Humor Break: Is Obama A Keynesian? Rally For Sanity, 10/30/10

This is so funny, especially the one lady who just gets outraged!!

For the record - a Keynesian is a reference to an economic policy put forth by John Maynard Keynes (Government spending during down cycles), not someone from Kenya!!

Scott

Taleb: Ten Principles For A Black Swan Proof World

I thought I'd start November out with some words of wisdom from Nassim Nicholas Taleb, author of two of my favorite books (Fooled By Randomness and Black Swan).

My favorite story that Taleb tells (which is appropriate for November) is that of the Thanksgiving Turkey.


——

CHARLIE ROSE: And what is the story of the turkey?

NASSIM NICHOLAS TALEB: In the book, I have the story of a turkey that is fed for 1,000 days by a butcher, and every day confirms to the turkey and the turkey’s economics department and the turkey’s risk management department and the turkey’s analytical department that the butcher loves turkeys, and every day brings more confidence to the statement. So it’s fed for 1,000 days…

CHARLIE ROSE: Gets fatter and fatter and fatter.

NASSIM NICHOLAS TALEB: Fatter and fatter. On the day when its comfort will be at its maximum, there is going to be a surprise. There will be a surprise for the turkey.

CHARLIE ROSE: Yes.

NASSIM NICHOLAS TALEB: There will be a surprise for the turkey’s economics department, all those Ph.D.’s. Will it be — after all, there’s maximum (inaudible)…

CHARLIE ROSE: But it’s not a surprise for the butcher, is it?

NASSIM NICHOLAS TALEB: Not a surprise for Charlie Rose as well. Not a surprise for humans. It’s a surprise for the turkey. So the whole idea here is we are not to be a turkey.
——

Who or what might be the next turkey?

And Now Taleb's Ten Principles:

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk- bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning . Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.
In other words, a place more resistant to black swans.

Happy November!

Scott Dauenhauer, CFP, MSFP, AIF