The Fed's Explosion of Money

There is a lot of research that I want to do for this blog. Some is reasonablely interesting like looking at the thoughts of capitalist economists and supporters of freedom. Some is like driving nails into your head, e.g., looking at government statistics. Of particular interest to me is the activities of the Fed. The Fed is always important, because it is so important to the economy, unfortunately. It is even more so now, and I have been in their website lately.

Specifically, I wanted to look at the manipulation of bank credit by the Fed. The Fed makes a lot of information available online. Some is very revealing. Other parts are difficult to dig through. I am only in the early phase of my work, but I found something that you might find interesting, and frightening.

I was looking for member bank’s deposit information. I found two such listed entries in a release of weekly data on the Fed’s open market operations page. These two entries were derived in different ways, in spite of being listed with identical titles. They tracked each other, so I don’t think that it is a major issue. They also vary a lot from one week to the next. I haven’t yet figured out why. The Fed does a lot of different things to the member’s deposit accounts, so there are a lot of moving parts. I also figure that over time you can see trends. But what I found is amazing.

I began collecting the data from the two listings beginning with the first week in 2007. Throughout 2007 and most of 2008, the levels of the two listings vary with a band of about $15 B on what I call MD1, with a bottom of say $5 B, and $25 B on MD2, with a lower figure of maybe $8 B (approximations). Then in September 2007, all hell broke loose.

Why is this important? The Member’s Deposits is the primary tool the Fed uses to expand bank credit and thus the money supply. Each bank (I am talking about the large banks) must have 10% of its demand deposits (checking account deposits) in its “reserve” account at the Fed. If it falls short the bank can borrow (from the discount window or from another bank). The Fed can also add or take money away from this account. When it adds, the bank can expand its demand deposits by making more loans. The Fed can also change the percent of deposits required and what constitutes the required deposits. The current practice is one of the loosest that I know of since the Fed was created.

So here we have these important deposits staying fairly level for a year to two. Actually the records accessible online go back into the 90’s. I want to look at it all. Now I say level. Actually when I look closer I expect to see an upward trend. I haven’t looked because what I found just blew everything else away.
Okay. What did I find? Up until mid-September, 2008, the average for MP1 was, say, $8 B, and for MP2 $15 B. By the end of September each was about $100 B, by the end of the year $800 B, today $1 T. There is no limit on bank lending. This isn’t a gentle push. This is a demand that banks loan money, lots of money. They aren’t, not yet, but they will. (I've got an Excell graph. If I figure out how to upload it, I'll put it in. It is the hockey stick!)

Notes and Commentary On "Crash Proof 2.0" Part 2

Chapter 5, p. 148: 2009 UPDATE

This chapter is about the stock market and the Dow Jones Industrial Average, which was at its recent low under 7000 when Schiff was writing. It is now in the 9600 range. Probably, Schiff would call this a bear rally.

p. 150: He expects to Dow to go to 4000 to 5000 and last for 5 to 10 years. ???? Unexplained.

p. 151: He refers to GE, which hit $5.72 in March, 2009 is now at $16.08 at a P/E of 12. He considers the Price/Earnings Ratio to be important. 12 is way below the traditional average.

p. 152: “Therefore, much of the big profits earned by such companies through their financial activities from the 1990’s on…were phony.” Here we are again. Jump. Phony because the financing was supported and the interest rates kept low by the Fed’s massive money creation. But how that makes the finance arm’s profits more phony than any other part of the company I do not know. It is true that those activities cannot be sustained because the Fed’s inflationary policies cannot be sustained. But dollars from one sector spend just as well (or poorly) as dollars from another sector.

Chapter 6, p. 186: 2009 UPDATE

For this chapter I have nothing to add or criticize. Not bad

Chapter 7, p. 227: 2009 UPDATE

p. 228: “As I noted in the chapter [of the first edition], the Social Security Trust Fund is a pure case in point [of a Ponzi scam].” Okay, this is not a big point, as far as the book is concerned. It is as far as he goes, however. He did not explain the Social Security Trust Fund in the chapter. He mentioned it. He did explain Social Security. He did not explain that Social Security is a very big problem looming just around the corner.

Nor did he explain that Medicare, which is already bursting out of its direct tax revenue and eating into the General Account, i.e., income taxes, etc., is an even bigger problem than Social Security, and it is starting now. The correct description is that Medicare is selling its special Treasury Bonds in its Trust Fund back to the Treasury. It is a fraud.

Perhaps, and this is just a perhaps, Schiff is so much of a finance guy that no other issues are big to him.

p. 231: “Out of this pseudo economy emerged the now-dominant service sector….” Here we are back to the service sector. Now, at least, it is only “dominant” in stead of providing services as the only thing we do rather than manufacturing.

I do not want to attribute this to Schiff without some evidence, but maybe the reason why he places the service sector here is because he cannot find another culprit for the deficit. I don’t know. But harping on the service sector only undermines what is often decent material. What he sees as the service sector is also very narrow. But, ultimately, he just doesn’t look at our economy as part of the world economy. It is. So is our service sector. Services, as long as your not restricting the definition narrowly to menial tasks done locally, are actually easier to transport and provide than physical goods. Looking at the U.S. as part of the world, offering services makes us very flexible in a rapidly changing technological world.

p. 234: “China funds about 50 percent of our borrowing,….” The numbers do not add up. Let’s say that our trade deficit is $800 B and that our federal deficit is $1 T. So, Schiff is saying that China receives three fourths of our trade deficit, and the put all of it into our Treasuries. Our total imports, which went down this year, were only $2.4 T, which means that China would have to be on the selling end of more than half of our imports. No, they weren’t. If he is going to throw numbers out, I wish he would give us some idea where they came from. I do not want to accuse him of making them up, really.

What numbers that I can find shows that out of the total U.S. federal debt of over $10 T, 25% is foreign owned. It could be that foreigners are buying 50% of new debt, expanded debt. I would still like to see his source.

p. 235: “In effect we imported foreign goods and exported inflation.” My very words. Where do services stand in this statement?

“…foreigners get to keep their goods….” This is part of his “decoupling” thesis, often mentioned but not explained in this book in either edition. I think I know what he is trying to say. The problem derives as to why the Chinese exports are so attractive, to focus on the country that Schiff refers to most often. They do not want many of the things that they build for us. The goods they do want they buy in as large a quantities that they can afford. I don’t see that the production capacity that they use for export is of much value within their country. Their general population is, after all, low income.

I will say that I generally agree with his analysis of the federal bond market. The current low rates cannot continue, the market will not buy a continuous stream that shows no end, ultimately, the buying of bonds by the Fed, with or without the trick of expanding bank credit, will reach consumer prices, with the help of dollars held overseas coming home. Price inflation will rise, and tend to rise at an increasing rate.

A general note, which applies since the last chapters are about investment advise. Schiff has not discussed the Fed’s major tactic of expanding the credit supply via the use of member bank’s deposits. It may not be relevant, or desirable in this book, but I often wonder if he knows.

Chapter 8, p. 273: 2009 UPDATE

p. 275: Schiff apparently has many other writings on the internet in which he explains much of his thinking. He left a lot out of the earlier edition of this book. Now, in the revision/add on, he sort of writes as if the reader had read the other stuff as well. Here, finally, he recounts some of his broader views that make some sense of the first edition.

p. 280: Another problem I have here is that he states several events as facts. They vary well might be, but I would like to see myself. Schiff does not give me a way to find out. There are no references. Okay, finding out is not as difficult as it once was. Go internet.

“The world is rapidly waking up to reality.” This time some evidence would really be worthwhile. I do not see this happening. I think that the central bankers around the world are still the same central bankers. They have not all of a sudden had a brain transplant. Private actors, currency traders, businessmen, investors, etc., may be, but again, having some reference to substantiate this would be helpful. Schiff acts as if anything he says is to be totally accepted. Please.

“I’m talking prosperity and growth unlike anything we could imagine when those nations had their wings freighted with the United States’ excessive debt and trade imbalances.” Does Schiff realize that all of these countries are less free than the U.S. was prior to the 60’s? Further, I do not understand how their internal economies, or even several countries, or the entire rest of the world, is going to absorb the production that the U.S. has received, or even a significant portion of it, without experiencing drastic reductions in the prices of everything. It isn’t as if there is all kinds of ready money, real or otherwise, sitting around to buy what the U.S. can no longer buy. How does Schiff expect that to work. The central banks in the other countries look at their economies not that differently from the Fed. If they see prices begin to drop they may just as well act as the Fed would and pump money into their economies, and bang, have the same problems we have. Schiff needs to explain how this works. I don’t see it.

“We are already seeing signs of decoupling….” Meaning that foreigners are tending to buy fewer U.S. Treasury Bonds, sell dollars, and not expect to sell goods to the U.S.. So, where does he see this?

p. 281: As the world’s producers begin making more for themselves and less for us, they will demand even more basic commodities, while recent capacity reductions will further limit supply.” But also, we will be demanding less, and therefore some supply will be opened up. But, as I said before, it is less obvious how the other countries are going to be able to take advantage of “making less for us” without prices dropping, which means that they will have less ability to pay higher commodity prices.


Chapter 9, p. 309: 2009 UPDATE

p. 311: “I do not believe there will be an official decree to replace the dollar as the world’s reserve. It will simply lose that status due to independent market forces. My guess is that central banks will began [sic] to hold more of their reserves in other currencies, such as the euro, yen, or Chinese renminbi, and significantly higher percentages in gold.”

Let’s consider what the situation would be if the U.S. had not been exporting inflation, i.e., made up dollars. Let’s say that the $10 T that is currently being held by foreign central banks and the $1 T held by foreign private interests were part of a stable currency. Of course, that could not have happened, because about 30 years ago our total liquid money supply was about $1 T. What would have happened is that as we sent dollars overseas to buy goods, they would have held on to them, pretty much as they held on to the made up money. Dollars would have disappeared from circulation in the U.S., and prices would have had to go down, simply because there were fewer dollars around to spend on things. Wages would have gone down, too, but not as much. This scenario would be just like the last few decades of the 19C. Internationally, the dollar would be bid up consistently, year by year, making foreign goods even cheaper and more attractive. Our standard of living would improve, especially as we became more productive and allowed our creative people to create. What a world.

The point of going through that scenario is to point out what would happen in countries whose currencies would be chosen to be reserves. Every yen taken out of circulation in Japan is one less yen being used for prices in that country. There isn’t much of a yen bond market. The situation would be similar for the euro.

As I mentioned in an earlier note in this commentary, the central banks in those countries do not view falling prices as a good, and would tend to make more money to replace money that was effectively exported, and the cycle would begin, as it did here.

I do not think that gold would be the general response because it is too restrictive. Central banks could not do what they consider their responsible activities of controlling the business activity within their countries.

Schiff has this unrealistic view of what other countries are like. They have an even lower attitude toward the free market than our “leaders” do, and less experience. (I am willing to consider exceptions, but those would not be major economies, I expect.) I would not expect milk and honey in China, Japan, Korea, and certainly not in Europe.

On the other hand, I think that Schiff’s expectation that gold will continue to rise in the long run, or even intermediate, is accurate. What’s to stop it?

“…the fact is that the world does not need a reserve currency. Rather than replacing the dollar with some other flawed fiat alternative, the world could simply return to the traditional gold standard that existed prior to Brentton Woods.”
Well, yes, that is what it should do. But, to do so, it would have to recognize why. The Chinese do not. And I see no reason to think that anyone in the governments of the other major players understand either. The fact is that governments that exist today prefer fiat currencies, and really have no problem with a fiat currency as a reserve. If they have a problem with the dollar it is because the U.S. has gone overboard, in their opinion.

p. 313: “…but I’m also surprised at the extent to which the European Central Bank (ECB) and other foreign central banks have adapted inflationary policies.”
Mr. Schiff, U.S. central bank policies were patterned upon foreign central banks. We did not invent the central bank, the Europeans did.

The balance of this section is, in my opinion, sound.


Chapter 10, p. 335: 2009 UPDATE

In this section Schiff sort of ping-pongs around, accurately demonstrating the problem with suggesting the thing to do in our current situation. What to do?

If his expected economic disasters come to pass, it is very unclear when they will. This leaves the asset holder in a difficult quandary. If his second collapse is as drastic as he expects, then holding the right things will wipe them out just as much as holding the wrong things. The most important assets to hold may be gold, food, and weapons. That is the worst-case scenerio. Frankly, if you expect the worst case, you should be moving to a small town in an agricultural area, get to know your neighbors, help on farms, buy some gold coins and bullion, and hunker down. Holding foreign stocks might not be helpful.

If, on the other hand, you expect things to be hard fought, that the efforts by yourself and other Objectivists and people who want freedom are going to have enough of an effect to keep things running well and then turn around, owning foreign stocks, gold indirectly, and a selection of solid U.S. companies would make sense. I do not think that someone who felt that reason has a good chance of prevailing today would give up entirely on U.S. companies.
Not a good set of choices, sorry.

Notes and Commentary on "Crash Proof 2.0" Part 1

p. vii: “More importantly, while most believe that the economic collapse is over, the reality is that it has only just begun. What we have witnessed thus far are merely the events that have set the collapse in motion. It will take some time for all the dominoes to fall. But fall they will, perhaps even more spectacularly now than how I initially envisioned back in 2005.”

p. viii: “…you to see that our problems today are the consequences of pernicious fundamental trends that I have recognized and warned about for years.”

Maybe. They were not really in the book. He did warn about the residential real estate mess. Credit to Schiff. Lots of credit to Schiff. I think that he has shown some ability there.

Yet, the thesis of the book, the collapse of the dollar, has not occurred. We’ll see what he has to say.

Chapter 1, p. 24: 2009 UPDATE

p. 27: “…and provide the capital investment that entrepreneurs need to create jobs and finance the production of exportable goods.” ???? Where did this emphasis on exportable goods come from? Why does he get so excited about exportable goods? Why does “exportable” matter? Why not just goods, goods for everyone?

I need to say that the sections that I am not commenting about are at least decent, and often good.

p. 29: “But buying stuff we couldn’t afford with money we didn’t have was what got us into this fix.” While this is true, it is superficial. I fear that as long as he focuses on consumer oriented thinking, he will be letting our opponents off. What he needs to focus on, which he has elsewhere, is the inflation that underlies the consumer spending. Much of this behavior is driven by the cheap money policy and the mistaken notion that the key factor in an economy is consumer demand. With an emphasis on production and the manipulation of the money supply stopped, people would not benefit from over spending and the practice would be less prevalent.

“Rather than encouraging American borrowers to once again tap the savings of foreigners….” We weren’t getting the savings of foreigners, we were getting our own previously made inflation dollars back. This is one of his worst statements in that, one, he is claiming something that sounds so vile and, two, he says it with no support, in this case, with not even a supporting explanation. I expect that he is referring to the U.S. federal debt that is purchased by foreign central banks with dollars they hold in their reserves. These dollars come into the local economy as exports are sold to the U.S. The exporter then trades his dollars to the central bank in exchange for local currency. As long as the local currency is not being inflated for this exchange, then the process to then is neutral. The problem comes when the central bank just holds the currency instead of allowing it to continue ciruclarating in international commerce. This is a drain on the local economy. But these are still dollars created by inflation. When the central bank then buys U.S. federal debt, it is putting our inflated dollars back into our economy, which is then spent as “real dollars” here, and will tend toward pushing up prices. It is still difficult to see how we are tapping into the savings of foreigners.

At the end of the page he actually said, “worst-case scenario” regarding the “crash” he has been predicting with each book. That means that the outcome that he has been using to frighten his readers is now regarded as a worst case.

p. 31: “I have always said, however, that it wouldn’t happen overnight.” Ahhh. Please show me where in the first book that was said. In this book he seems to be encompassing all of what he has said anywhere as opposed to just Crash Proof. What is a crash but an overnight event.

p. 32: “It’s absolutely unarguable that they [foreign economies], not we, are the engine of economic growth.” This very arguable statement is an assumption that undermines his entire argument. If he recognized that there is a strong foundation still in the U.S., he would be a better analyst and predictor. He is good in some respects. He could be better. Schiff is an intelligent man. I do not understand why he would make this statement and provides no support. As I say, I have not looked at everything he has written or said, but in what I have seen, including his most public presentation, Crash Proof, he offers little evidence to support his conclusions.


Chapter 2, p. 53: 2009 UPDATE

“Clearly recent events have proven my point: Wall Street, the U.S. government, and the mass media have been using manipulated data to foster a falsely optimistic view of a ….” I don’t see where he gets this. It isn’t the data that confuses those people. It didn’t confuse Schiff. What confuses most people are their ideas, their philosophy. Schiff’s confusion on this point is a reason why I am not impressed with the claims by his supporters that Schiff is a defender of reason or a follower of Ayn Rand. He just doesn’t demonstrate a recognition of the importance of ideas. His point here is that if these people looked at good data they would act differently. No, they wouldn’t.

He does end the paragraph with the accurate point: “Even more distressing, to my mind, is that the experts did not actually understand the problems threatening our economy.” That is correct. I wish he would show that he, Schiff, knows why those experts did not understand.

p. 58: “Note, too, that a 1 percent fed funds rate provided the stimulus that sparked the housing bubble and made teaser rates so enticingly low.” While this is technically true, it is not really helpful. I mean, how does the Fed keep the rate at 1 percent and how does that “provide the stimulus”? Without that information I think many people, including many who reasonably agree with him, are left with a floating abstraction. It needs to be explained.

p. 61: “…our economy is fundamentally broken.”

“But we spent an excessive amount of money on consumer goods with the result that we don’t have the manufacturing bases….” Still don’t see how spending on consumer goods, excessive or otherwise, or importing a lot of it destroys our manufacturing base.

His basic point in this section is correct. We have not learned from our previous mistakes.

“When the problems predictably worsen, let’s hope Washington finally learns the proper lesson.” He is right about the lesson to be learned. But he doesn’t understand that Washington as it is now constituted (and the last administration as well) is incapable of learning.

Chapter 3, p. 83: 2009 UPDATE

p. 84: “…where I had predicted earlier that the Dollar Index would likely bottom out at around 40, I now see a bottom closer to 20 or maybe even lower.” It was around 70 in March, 2008. He does say when or how fast. The timeline would be the difference between a crash and a decline. I do not disagree with a decline, a continuing decline. I wouldn’t begin to suggest a number. A crash won’t happen. Strategies for retaining value in your assets would differ between a crash and a decline. A slower decline would offer some chances to do something about it, if we had the opportunity. A swift decline or a crash would bring us to a desperate situation.

p. 85: “As our trading partners see it, they were watching their best customer go down the tubes, and their first reaction was to come to its rescue.” Yes. And the fact that they have $10 T in dollars and bonds. They are not going to want to see that go down the tubes either. Which has been my point.

This section is an excellent description of the interrelatedness of our world economy. The U.S. is a very significant part of it. Schiff’s decoupling would shrink the world economy drastically, and the consequences he relates in this section would happen again. His tag line that they should stop manufacturing for us and do it for themselves is so screwy.

p. 88: “The problem is that too many people lack the sophistication to understand why [foreigners supporting the U.S. dollar and selling goods to the U.S. is harmful].” Again, he shows that he does not understand the importance of ideas. The currency and bond traders of the world, the manufacturers and exporters of the world, and businessmen, wealthy people, and so on, are not unsophisticated. To the extent that they are making bad decisions as envisioned by Schiff, they are miss-trained. They have bad philosophies. But, to some extent, they are making some reasonable decisions, since Schiff is incorrect in claiming that the U.S. is an economy without foundation.

p. 89: The last sections are reasonably good. The bond market is going to see higher interest rates, even if the Fed tries to support low interest rates. There will just be too many bonds. The Fed will have to flood the market with credit. Schiff does not mention this but things will be rockier as Obama’s plans play out. After that we will get the huge increases in Social Security and Medicare spending, and we will have taxes that will take up every bit of capital and discretionary spending.

“When this rally ends, the bottom is going to fall out of the dollar.” So we are back to the collapse. Well, I think that the post-panic government actions, plus Obama’s programs could do it. Interestingly, Schiff has not mentioned Obama’s programs directly. He is focused only on the bailout. He hasn’t mentioned Social Security and Medicare.


Chapter 4, p. 118: 2009 UPDATE

p. 122: “If we were still on a gold standard, as was the case during the 1930’s….” While technically we were on the gold standard in the 30’s, it was not a real one. FDR famously sat down with one of his “economics” advisors every morning and decided what the gold price should be. There was also lots more gold than there were gold certificates, meaning the Fed could make as much money as it wanted, and did.

Schiff constantly refers to inflation in terms of “printing presses”. I think that this is so misleading to people. It is so simplistic. I understand that using accurate terms is more cumbersome, but accuracy and precision of language is important.

p. 123: “…and now that we are in a downturn, we have even more inflation because the money supply is growing even faster.” Is it? I know it will. But it isn’t now. Credit is still dead; no lending is going on. This is why his using the term “printing press” is a problem. He is not using in his descriptions what he does know, that inflation in the U.S. is caused by bank credit expansion, and the lowering of the dollar because of the size of the foreigner dollar holdings the exist because of credit expansion in the past. So he knows that, although the Fed is certainly trying to get banks to lend, they aren’t. Thus, there is no inflation now. That will reverse, and with the amount of new government debt, the idea of stimulus, and the goal of low interest rates, bank lending will pick up, grow and grow and grow. Inflation. It will burst out somewhere.

“Many argue that all this money printing is not inflationary as it merely replaces the money lost due to debt defaults. However, this naïve view fails to account for the loss of output represented by defaulted loans.” ????? The loans were mortgage-backed securities based on loans to people who couldn’t make their payments. Where is the loss of output? My problem is that I do not see the connection between these two sentences. He does not deny that the bail-out money is replacing reserves and capital, and is not particularly inflationary (it is not good for us). And a recession has a loss of output. Is he saying that since there was a loss of output that there should be less money in the system? Is this loss of output permanent? I am not seeing these connections.

p. 125-6: “Why Inflationary Pressures Will Prevail” This is a very curious section. He talks quickly about a vast array of economic actors, including commodities, consumer goods, credit, farms and mines, retailers, etc. But nowhere does he talk about the Fed and its money machine? When someone tries to declare what is going to happen at this level of detail, they are always wrong, because the number of actors and factors is too large. He needs to stay on the broader level on which he usually works.

p. 126: “The Real Game Changer” This analysis of the value of the dollar in international trade is correct, but I wonder at the size of the impact. I think the bigger impact within the country will be the Federal budget, the higher interest rates, and most important, the Fed’s actions. The fall of the dollar will have its impact, but will not be as big as Schiff thinks. He seems to go back and forth as to what is most important. But he always returns to the value of the dollar in international trade. I wonder why? The reason that I say that it will not be as big a deal as he thinks is that international trade is not a large segment of our economy. We have already seen a nearly 50% drop in the value of the dollar against the Euro and the Yen, even the Canadian Dollar is much stronger against our currency, but we have seen little effect within the country. Perhaps he is expecting the U.S. government debt to have fewer buyers. This idea ignores the trillions of dollars that will still be out there and the very few places that it can be placed.
The one way in which his analysis could be correct is if some major holder dumps their dollars. The major players include England, the Euro Block, Japan, China, probably Canada, and maybe one or two of the oil producing countries. One of them would have to decide to start selling their large holdings of dollars. One of the first events would be the other countries buying to protect their vast holdings of dollars.

Crash Proof, 2.0; Review

Peter Schiff’s newly published book has an unusual organization. It is the original Crash Proof, exactly as originally published, with updates written in 2009 at the end of every chapter. He has changed none of his positions. At least some of his positions and predictions came to pass. He crows about this repeatedly. I don’t hold this against him, mind you. In fact, in his business, where often even if the market goes the way you predicted, you are wrong about why, so everyone is wrong. Being right significantly is worth crowing about.

Since the whole original book is intact, all of my original problems remain. I will not repeat them (see the original review on this blog).

The “Updates” generally extend the ideas in the original text, including the ones with which I disagreed. In some cases, he makes clearer what those ideas are, and why his original ideas are not quite right.

I thought that the following quotation demonstrates what may be his biggest confusion: “…but I’m also surprised at the extent to which the European Central Bank (ECB) and other foreign central banks have adapted inflationary policies.” (p. 313) He has consistently treated the U.S. as a country that acts differently than every other country. Yet the concept of the central bank and how it should function is a European invention. The fiscal policy that our country follows was created by our old friend Keynes, an Englishman. All of the central bankers in the world went to the same schools, read the same texts and authors, and talk and communicate all the time. Why does he think that they wouldn’t all act the same?

Even worse is the following: “I’m talking prosperity and growth unlike anything we could imagine when those nations had their wings freighted with the United States' excessive debt and trade imbalances.” Does Schiff realize that all of these countries are less free than the U.S. was prior to the 60’s? Why is just not selling to the U.S. going to bring on the days of milk and honey?

Also wrong about that quotation is that the trade imbalance is the result of foreigners holding on to our dollars. If they had not held on to the dollars, the foreign central banks would not be faced with the problem with where to put the money, and they would not be funding our debt. If other nations, especiall China in recent years, had spent the money, the dollar would be much lower, we would have had to finance our own debt and interest rates would have had to be higher and there would have been more restraint. I'm not saying that our problems are the fault of other nations. They are responsible for the number of dollars they hold on to.

A criticism concerning understanding the book comes from the fact that Schiff has written and talked (audio and video posts) a great deal on the web. His stronger supporters are familiar with this material. I have read one or two things, seen two or three short videos, and heard one audio piece that went on for about an hour. In the online material somewhere, Schiff has developed some ideas that did not appear in the first book, but he mentions briefly in the 2.0. Most importantly among them is the idea of “decoupling”. This is very important in Schiff’s thinking, but it is not explained in his book. I do not think that I can adequately present the idea with its supporting argument. Generally what decouples is the Asian economies from U.S. purchases and government debt. As a result they have “prosperity and growth unlike anything we could imagine”.

I disagree. To have that growth in mature economies, they would have to have freedom. The reason they got there was the support of the country that was, and hopefully will be again, the freest in the world, the U.S. If the U.S. hadn’t existed, they would not have cleared the 19C.

The last three chapters contain advise as to how an investor can protect himself and perhaps even profit while the U.S. economy suffers. There is some interesting advise there. Schiff does recognize the major issues, e.g., timing and changes in the laws. As with my above comments, I don’t think that he realizes that what happens in the U.S. is going to have significant adverse effects elsewhere. (In my notes that I will publish after this review I discuss what would have to happen in the “decoupling”). Without considering what could happen in other countries, I think that Schiff’s discussion lacks completeness. It is still worth reading, if you keep both the shortcomings in mind.

I also think that his comments on Treasury Bonds and the actions by the Fed are decent.

Actually, if it weren’t for his shortcomings regarding the rest of the world, he would be good. Certainly much better than most of what you can find these days.

A Flight of Fancy (Not Fantasy)

If we think about the economic problems that confront us, now at the beginning of the 4th quarter, 2009, we might think that we could be overwhelmed. There are several major, dramatic, colossal problems. At least a partial list includes:
-As John Lewis pointed out, soon we will see the backbone of the welfare state come rolling in to beat the living hell out of us. The potential cost of Medicare and Social Security will take up every dime that isn’t nailed down.
-Obama wants to completely destroy the medical profession and our health. The cost will be far beyond what anyone has been willing to mention in the current “debates”.
-Our trade deficit, which has pumped over $10T out of the country over the last 30 years, has brought down the value of the dollar significantly in the last few years. I don’t think that anyone is foolish enough to actually dump dollars, but the dollar-sell side of international currency markets is going to be continuously stronger as long as there is such an abundance of dollars. Don’t forget that the trade deficit is still occurring, and that the reasons for it existence are still in place.
-The national debt is growing at an unbelievable rate. We will have an amazing debt.
-The amount of money that will needed to support Obama’s programs, and the other run away “entitlements”, plus the fall of the dollar, will lead to a pressure on retail prices that we have not seen since the 70’s.
-We may have another oil price spike, or maybe a little longer one.
-Needless to say, life will be tough, or could be.

But, and this is the biggest “but” I think I could ever write, there is a solution. To many of you, this won’t be a surprise. It is an easy solution. It is no secret. It is the easiest thing in the world. All we need is freedom.

There is actually only one problem. It is the philosophy that gives us the government in place now. If we get rid of that, we are home free. All of these problems will be quickly dealt with and forgotten, except as history. We always want to remember the mistakes in history.

Why do I say that these economic problems will be swept away? After all, for example, those citizens that have become dependent on government programs cannot be just abandoned. I am not claiming that we have a “duty” here. No. But every discussion that I have seen begins with the premise that the change to freedom needs to have some elements of a transition.

Of course, some things would happen immediately, e.g. we would get rid of regulations, market limitations, certain kinds of government spending, property restrictions, ecology controls, and so on. Many government departments would just be liquidated. No unemployment insurance would be in place. The Fed would be taken out of the money manipulation business. As we work back to a gold standard, the dollar will stablize.

But think of it. We would be free to produce. Think of the level of production we could achieve if we were not encumbered. Remember the later Clinton years, when the only stimulus was the lack of new rounds of regulation, and maybe a little half-hearted deregulation (still with enormous amounts of inflation). The economy grew at a pace that “theorists” thought impossible for a “mature” economy. Without restrictions, our growth rate will astound everyone.

A good economist will tell you that the only actually limited resource is people. Guess what, all of a sudden we will find that we have a 10% to 20% increase in our working population, our productive population. All of those people, who have been involved with regulations, taxes, controls, etc., will have to find productive work. Many of these people work for private enterprise today. A significant percentage of businesses’ budgets and personnel will be available for production, not government work.

Yes, a lot of the ex-government employees will not be fit to work. Should we be concerned about them?

The federal deficit will be taken care of in two different methods. Taxes will ramp down. How fast is strictly a practical matter. With real production in our economy, tax rates will not need to be high.

What may not come to mind immediately is that the federal government has considerable assets. Actually, real assets. It has buildings. Thousands of buildings. Most of these buildings are in valuable locations. The buildings themselves may not be worth much, but the locations are. Plus, the government has lots of other stuff that can garner some cash.

Most of all, the assets of our federal government include land. West of the Mississippi, the government owns 66% of all land. Yes, lots of that is in Alaska. Even so, managed properly, the federal land could probably pay off the federal debt all by itself.

Perhaps the biggest problem will be the Medicare mess. Even if we were to start ramping that program down now, it would still be a mess for a couple decades. However, we shouldn’t discount the consequences of bring back freedom, including eliminating the Medicare bureaucracy and all of the limitations that have been placed on the practice of medicine and insurance. There may be some price pressure in the medical sector for a while, but it think that it is something that free men can handle.
So, we do not need to worry about the afterwards, not really. We just need to get rid of Obama and his mentors and followers and let freedom reign.

Status of inflation and prices today, September 2009

I have four things to say about inflation, prices, and the state of today’ economy, late September, 2009.


NO CREDIT EXPANSION CURRENTLY
One, since inflation is introduced into our economy by means of credit expansion, which means bank lending. Currently, because of the nature of our current mess, i.e., a financial panic, bank lending has shrunk and credit availability has all but disappeared due to the liquidation of bank capital and reserves. You might ask about the money that the federal government has put into banks. It was a lot of money. That money went into three areas. Some did go into the credit area, as the government purchased bad debt, those sub-prime, mortgage-backed bonds. But the government bought them at an extreme discount, so it did not replace much of the credit. The other two areas in banking that received money were those of reserves and capital accounts. These accounts within a normal functioning bank, consist of a significant percentage of fund, maybe as much as 50% of the bank’s checking deposits. However, these funds are not spent, not really invested. They must remain available for the bank’s needs. Consequently, they have never been part of the money supply, M1 or MZM, and cannot really be considered inflationary. The real problem with all of these measures by the government is that the recession hasn’t been allowed to do its work. The misallocations and created money have not been worked out of the system.

FALL OF THE DOLLAR
The upperward pressures on consumer prices today come primarily from two sources: one, the fall of the international value of the dollar. Foreign goods and services are now considerably more expensive that they were just a few years ago. The dollar has dropped in value almost 50% in just a couple years.

There is a second consequence for prices. U.S. goods and services are much cheaper for foreign buyers. That might sound good, but what it really means is that there are more dollars chasing our domestic production, which will mean higher prices for us. It is a double whammy of price inflation.

The current fall of the dollar is happening because foreigners hold so many dollars. They are finally spending them instead of holding on to them. They have been accumulating dollars for almost three decades, from our trade deficit. There is almost $11T in dollars overseas. All of these dollars that we have exported were created dollars. Notice that during the time that foreigners accumulated $11T, we still had constant 2% to 3% price inflation as our domestic money supply grew to over $10T. New money was being created at a tremendous rate. Now the overseas money is beginning to return. It is from our past inflation.

OIL PRICE SPIKE COMING!
Third, there is probably another event that is going to happen soon that will affect us financially. The conditions that produced the oil shock a couple years ago are returning. The world has no new capacity, and none coming on line in the foreseeable future. The existing industrialized countries have not reduced their requirements for oil, and will not do so, unless they retreat from industrialization. Finally, the two largest countries in the world, which are slowly moving into the modern age, and slowly increasing their need for energy, are slowly reemerging from the recession. We are all slowly reemerging from the recession. As we reemerge, more demand for energy will drive the spot prices for oil beyond what it was two years ago. This is not inflation. It is forced shortages. Prices will go up. All goods and services are dependent upon energy, and as energy prices go up, so will all the others.

MEDICARE AND SOCIAL SECURITY SHORTFALL: A REAL MESS!
Finally, in the relatively near future, we come to the fruition of the Medicare and Social Security mess. Medicare already costs more than the annual Medicare taxes bring in, and is consequently taking money out of general taxes. Social Security will follow suit within just a few years. Both programs will begin growing faster than realistic taxes can support. What will happen then? Depends a lot on who is in power and whose voices are being heard. As these two programs grow they will force out everything else, including Obama’s programs, and national defense! If instituted, Obama’s programs will just bring on the mess earlier because the poorer the economy performs, the sooner the shortfall between Medicare and Social Security costs and their direct revenues will occur. Also, the faster consumer price levels rise, the sooner the problem because both programs are tied to the price levels, either directly or indirectly.

The Federal Reserve Board and the Money Supply, Part 2

The Fed has this toy, the deposits of 10% of the country’s banks’ checking deposits. By law, the Fed can do two things with that toy. It can change the percentage of deposits required. If there is a limit on the percentage I haven’t found it. If there is a legal limit, it has no practical significance. We are really left with the Fed being able to set the percentage of demand deposits required by law with just the Fed’s “good judgment”!

The Fed also has the right to change the amount of money that is in a bank’s Fed deposit. The Fed can add money or it can take money away. So there are two parties who can change the bank’s deposits: the bank and the Fed. Now the bank is limited in how it can adjust its deposit. It must be close to the correct percentage. The amount of demand deposits the bank has is figured every week and it must reconcile the percentage at that time. It can borrow to cover a shortfall in its deposits. It can borrow from a bank that has a surplus or from the Fed (called the “discount window” and thus the “discount rate” that we hear so much about).

We are now at the key to the expansion of the money supply. Watch this. When the Fed adds money to a bank’s Fed deposit, the bank can consider the larger deposit as “found money”, and regard the new total deposits as the 10% (again, the current percentage requirement) the bank must meet. Since the size of the bank’s Fed deposit is now larger than it was, the bank may turnaround and expand the demand deposits held by the bank to the extent of the new proportion, 10 to 1, 10 parts demand deposits, 1 part Fed deposit. The bank expands its demand deposits by offering loans. Hospokus, we have credit expansion!

Let’s look at an example. Bank XYZ has $100M in demand deposits. From this, it has placed $10M at the Fed, and keeps, let’s say, $30M as actual reserves (I have no idea what banks currently believe is a reasonable, actual reserve, these numbers are made up by me). The Fed, acting upon its good judgment, puts $1M into XYZ’s Fed deposit, raising it to $11M, and whamo, the bank can expand its demand deposits to $110M. ZYX Bank can now loan out $10M more and be completely legal. (What percentage banks actually loan out is not really relevant. The Fed would just keep adding money to the deposits on hand until they reached their target of credit expansion.).

Whamo, we have now witnessed the expansion of the money supply by way of bank credit expansion.

The Fed uses a certain technique to add or subtract money from banks’ Fed deposits. The Fed buys and sells Federal Treasury Bonds on the open market. What it does, when it buys a bond, it buys it through a bank, and places the payment for the bond in the bank’s reserve. So, in the above example, it bought $1M worth of bonds through XYZ bank, and paid XYZ bank via the bank’s Fed deposit. If it wants to contract bank credit, the Fed buys bonds on the open market, and takes the payment from the Fed deposit.
The open market operation of the Fed is carried out by the, wait for it, Open Market Committee, which meets in the New York Branch of the Federal Reserve System. This Committee makes the open market policy and thus determines the rate of credit expansion. The credit expansion in turn causes an increase in the money supply, which may result in higher consumer prices. The credit expansion may also cause booms in stock prices, residential real estate prices, commercial real estate prices, and many other things. It also finances our export of dollars by way of our trade deficit. Credit expansion is handy for all sorts of things.