The Coffin Shaped Economic Recovery

The money supply has already expanded, and substantially so.

But the value of all assets fell. Money is not wealth, it is not all assets. The illusion that there is any constant ratio or gearing between the quantity of money and the total value of all assets is just that, an illusion. It is a notorious mistake dating back to the 18th century, and one every sound economist knows is balderdash.

Money is just one kind of asset. There is nothing magical about it. Demand for it rises and falls just as demand for sneakers or Toyota pickup trucks does. "But, but, demand for wealth is infinite!" Money is not wealth.

In the last year, the quantity of money in the US has increased about $1 trillion. But the value of all assets has fallen $11 trillion. Anyone who expects that to be "inflationary" because the first has increased, is attributing magical powers to money among all assets - which is does not remotely possess.

A year ago, 10% of US household net worth was held in the form of money or close money substitute forms of savings, like money market accounts and CDs. Right now, 15% is.

The demand for money rose, because it is safer than other long dated assets. Every time someone shouts "sell" for any other asset class, they are issuing so many "buy" orders for money, on the other side of every such transaction.

The only way there can be net selling of other assets is if the quantity of money increases, while issuers of other claims run them off by repayment.

And no, we will not "quickly flip" to "an inflationary situation", because (1) labor utilization is 90%, (2) capacity utilization is 70% (3) risk tolerance has collapsed (4) everyone is simultaneously attempting to reduce their credit risks (5) overall wealth has fallen nearly 20%. These are not the things inflations are made from.

In addition, the Fed stopped expanding its balance sheet in late April of this year. All of its emergency loan measures to support the banking system have been reversing since then, very rapidly. $700 billion in repayments have flowed back to the Fed in the last 6 months. The Fed as redployed that money buying treasuries and mortgage securities - most but not all of it, actually. But it is not engaged in further quantitative easing, all the hyperventilating pundits to the contrary notwithstanding.

The reality is, the hyperinflation thesis that all real assets would be worth an infinite amount in dollars *was* the bubble that comprehensively *crashed* last year. Those peddling the same story ever since are merely trying to redeem their past utterly mistaken predictions.

Dollar claims are frequently worth more than houses, or huge positions in oil, or other stockpiles of industrial commodities. Dollars are not confetti, and those recklessly going short dollars (which is what issuing debt *is*) were eviscerated last fall. We have since had mild half retraces of their capitulation selling to cover.

What we are seeing is not any precursor to hyperinflation, it is exactly what happens when half the world *bets on one* that *fails to materialize*.

There is, instead deflation.

Commodity prices are down by up to half, year on year. House prices are a third below their peaks. Consumer prices are down about 2% and producer prices 4-5%, narrower than the previous precisely because the Fed expanded the money supply to let some raise their dollar positions closer to their newly desired levels.

Interest rates are at 3.3% for the 10 year. Look at a chart of the great disinflation since 1980. Fits just fine. Everyone predicting instead that they must re-soar is belied by the market. They have in fact been predicting the same since 2001. TIPS are at 2% real yields. Inflation expectations over the next 10 years are the lowest since Kennedy was president.

Lots of people would find a hyperinflation quite convenient right now, to retrieve their over leveraged bets, their commodity speculations, their endlessly peddled doom, their political ideologies, their hatred of America or capitalism or the rich or just this admininstration - as though they were even distant cousins, incidentally.

But there flat isn't any.

And there flat isn't going to be.

You heard it here first...

Then, we were finally able to get inflation under control by abandoning the foolish attempt by the government to directly manipulate interest rates and instead simply focus on a stable monetary target.

In the current case, I think we’ll just limp along for probably quite a while. Truth be told, the banks need quite a lot of equity capital, but they really don’t want to take it from the government and give up more control over their own business. They’ll just continue to put the best face on things and try to muddle through. The government will do what it can to try to allow them fat net interest margins.

The Japan situation in the 80s and 90s seems to me like an apt parallel for right now.

(I didn’t mean you)

Congratulations on ten years.

Japan didn't have spreads, we do. Credit there was cost-free but rationed in practice as to who got it. Here people pay over 5% for mortgage money and take 1% on CDs. The banks are not going to go bust at those spreads.

You are so full of s* its digits stink across the internet. Of course you glibly ignore that only some money is cash money and a lot of it is credit money. Cash money is the stuff printed as federal reserve notes, checks, etc. and is called M1. Credit money is the stuff created by everyone else, i.e. commercial credit, etc.

Here is a plot of what has been happening to the cash part vs the credit part, i.e. M3.

Despite the expansion of cash, credit is not. So, all the assets bought with all of that credit cannot be sold at a higher price. Moreover, if you try to liquidate assets bought with expanding credit into a market where credit is flat, what happens to price? Hint, more goods, less money, the price drops.

It is classic monetary theory despite your poisonous dilusions.

Don't bother arguing. I know from long experience I won't change your mind. What I hope to do is innoculate everyone else against the disinformation you spread around. I don't know who you work for or why you do it.

Well, the velocity of money is down. That reflects a major change in behavior in the economy.

If psychology in the economy changes such that velocity returns to what we have seen in the past several years, yes, we could move back to an inflationary environment. I don’t think there has a been a permanent change in the American economic character. Individuals will binge on credit again if conditions present an opportunity to do so.

But as I say, I think we will instead just limp along for a while. I don’t think conditions that would present Americans with an opportunity for another credit binge will return anytime soon, for reasons you cite, such as low capacity, the weak aggregate jobs level and lowered average house values. And I suspect we are in a suckers’ rally right now in the equities market.

But a loosening of credit and capital would be a necessary precursor to conditions that would allow economic psychology to change, and the banks are still far too undercapitalized for that and I don’t see anything that would make a dramatic change in that in the near term.

However, if credit and capital were to start flowing again, one could see psychology change and velocity and money multiplier pick up, setting up the potential for inflation, notwithstanding high unemployment and in some industries low capacity, depending on what the Fed does. But I agree, that seems unlikely at least in the near term.

Given the continuing magnitude of the potential debt exposure, I don’t see fat net interest margins being enough to sufficiently recapitalize the banks in the near term.

You are exactly right! Simple but painful solution! It would look like one of those domino videos once it got started! Think of the transparancy at that point!

The velocity of money does not exist.

It is a fudge factor to obscure the patent reality that there is no relationship whatever between the quantity of money in existence and the total volume of transactions in an economy in a given year.

A dollar in financial circulation in New York turns over 1000 times more often than a physical currency dollar in a small town in the midwest.

There is no tendency, observed or theoretical, for the measured velocity of savings forms of money ("broad" money) to remain constant over time, even on average.

It can be proven as a theorem that the belief that it should is equivalent to a denial of the possibility of real economic growth. Which is false, theoretically and empirically.

The correct frame for broad money demand is not "velocity" or transactions-anything. It is desired money balances. Friedman recognized this, among others, it is not an anti-monetarist point.

Whenever desired money balances change, either the quantity of money in existence moves to accomodate that changed demand for holding money balances, or a progressive continual change in the exchange value of money will be touched off, until it does.

If men have higher money balances than they wish to hold, they will attempt to invest or spend them. Individually they can, but collectively they cannot - no such transaction reduces the money available to be held by all combined. The collective desire to get out of money can only raise the prices of what it is spent on, it cannot accomplish the desired shift. Similarly, a collective desire to raise money balances can only depress the prices of everything else in terms of money, but cannot be realized by transactions in existing securities, nor by savings vs. spending decisions. None of which increase the quantity of money in existence, they merely rearrange who has it.

Only the banks and monetary authorities as issuers of money can change its quantity to accomodate such a changed demand for holding money balances, compared to other forms of wealth.

The whole point of sound monetarist economics is that such shifts are real and that they *should* be accomodated. This has been distorted by naive quantity theoriest of the Fisher variety into a demand, instead, that the quantity of money never change - which is mere "restrictionism" applied to money, seeking to pay an unearned "rent" to existing holders of money by forcing it to a premium, by preventing its "production". There is no sound economic reason to accomodate that demand.

The Fed has reacted correctly to the panic demand for increased money balances. There is no reason whatever to expect that demand to be temporary or the transition away from it to be violent or especially inflationary. There is no reason to expect the ratio of M1 to GDP to remain mechanically fixed at whatever it was in 2006.

Money in existence has increased by $1 trillion in the last year or so. Total asset values fell $11 trillion in the same time-frame. There isn't anything remotely inflationary about a particle of that, now or for the immediate or foreseeable future.

Those fearing that it is, simply misunderstand what money is, radically, and the entire premise of their fear is false from start to finish.

It is reasonable to worry about reining in large government deficits. It is not reasonable to worry that the Fed's past monetary actions will cause some hyperinflation or collapse of the dollar. It is ignorant doom-mongering by failed economic theories, and no more worth paying attention to than ravings of Marxists about revolution.

Um, what do you think they are earning those interest margins on, kumquats?

Lending at 5 funded at 1 is profitable. Credit losses running above normal at 2.3% do not change that. Lending at 6 with funding costs at 5 and credit losses at 2 was not profitable, and that is approximately what stopped the bubble, when the Fed pushed short rates to 5%. But with short rates at zero, that is all over and done with.

One shouldn’t discount how quickly attitudes and market perceptions can change and what effect that can have on the real economy. A change in psychology can quickly affect businesses’ plans for employment levels, capital spending, borrowing and raising capital. It can affect how the banks look at the creditworthiness of their loan and securities portfolios and likely future charge-off levels, and in turn their appetite for extending new credit.

Expectation of a prospective political change can trigger such a change in market psychology. For example, if it becomes believed that a dramatic change in Congress will occur in 2010 with the result that the most economically damaging elements of Obama’s agenda will be avoided, and massive government deficits lower than expected, we could very quickly see a positive shift in economic activity.

In such a case, we might well see the equity markets firming up and the credit and capital markets loosening. Consumer confidence could improve and housing prices stabilize. Aggregate asset values and transaction volumes could begin climbing back up.

And what actions and policies the Fed takes in such circumstances will be very relevant as to whether and to what extent there is a prospect for inflation.

That change in psychology, and the possible prospect of inflation, could all take place within a time frame of a mere several months. Do I think it likely at this point? No. But things are fluid.

Some of us are skeptical that current charge-off rates sufficiently reflect the weakness of credit and securities portfolios.