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How quantitative easing works — or doesn’t (Part Two: Debt and growth)

October 31, 2010 Leave a comment

In the first part of this mental exercise we followed the wiki through the logic of Federal Reserve quantitative easing (QE) action up until the moment the authors of the entry embarked on a journey of patent misinformation. The authors of the wiki entry would have us believe that the banking cartel cannot create money unless it has sufficient reserves from which it can “grow” this money by lending some multiple of the currency it has on hand.

The wiki is absolutely wrong on this point: the banking cartel can create any amount of currency it needs, provided there is a demand for it, simply by making an entry into the account of the borrower, or in the account of the person from whom the borrower is making a purchase. In return for this entry, the borrower promises to pay the bank the amount of the loan with interest over some period of time.

Assuming our bare sketch of the “money creation process” is correct, this fictional money only comes into existence as a reflex of the same act by which it enters circulation, i.e., as the byproduct of an actual transaction. For example, it is the purchase and sale of a house that, simultaneously, brings about the creation of the fictional currency and puts it into circulation. Since, the banking cartel plays only a passive role in the transaction between the seller and the buyer of the house, its capacity to create money by entering a notation into the account of the seller cannot in any way increase economic activity.

Even a trillion dollars of excess reserves in the banking system cannot create home buyers; and, as Steve Keen has observed in a recent post, Deleveraging, Deceleration and the Double Dip, the increase in debt accounts for almost all economic growth in the post-war period.

For a long time I’ve focused on the contribution that the change in debt makes to aggregate demand, in the relation that “aggregate demand equals the sum of GDP plus the change in debt”. An obvious extension of that was that “change in aggregate demand equals change in GDP plus acceleration in the level of debt”—which would imply that change in unemployment is driven by changes in the rate of growth of debt.

Though I was aware of this implication of my analysis, I held off from testing it because I was concerned that this was pushing the data one step too far.

It turns out that I shouldn’t have been so cautious: the data well and truly supports this, on the surface, weird causal relation: the change in employment is strongly affected by the acceleration or deceleration of debt. This can give the paradoxical result that the level of employment can rise, even when the economy is deleveraging, if the rate of deleveraging slows. This phenomenon has driven the apparent stabilisation of the US unemployment rate (though of course the more meaningful U-6 measure has risen to 17 percent, and Shadowstats puts the actual unemployment level at 22.5 percent–well and truly in Depression territory), and it is highly unlikely that it will last.

My uncharacteristic timidity means that I have to doff my cap in the direction of the three economists who first published on this topic: Biggs, Mayer and Pick. They first showed the correlation between what they called “the credit impulse”—the rate of change of the rate of change of debt, divided by GDP—and both GDP and employment …

The chart below shows my confirmation of the relationship with the data on the annual change in unemployment in the USA and the annual rate of acceleration of private debt since 1955. The correlation is -0.67: a staggering correlation of a first and a second order variable over such a period, and across both booms and busts.

So, let’s step back and review:

The banking cartel can “create” money, and, then, use this fictional money to purchase something itself — the worthless fictional assets on its own books.  Thus, quantitative easing, despite all the rather dense and complex literature produced by simpleton economists, consist simply in an exchange of unsellable worthless assets for equally worthless currency. On the one hand, it is merely the accumulation of these fictional assets in the hands of the State — the socialization of the toxic product of fictitious capitals. And, on the other, the replacement of these worthless assets on the books of fictitious capitals by equally worthless, but always spendable, currency. The entire point of the exercise, therefore, is not the increase of the “supply of money” or “lowering the rate of interest”, but, rather, purging bank losses resulting from the collapse of fictitious assets. These losses are transferred to the State and the scam is euphemistically renamed quantitative easing.

However, even with this outrageous scam the newly created fictional currency could not enter circulation without some mass of sheeple willing to bury themselves beneath an ever higher mountain of debt. It was for this reason that the first round of quantitative easing was accompanied by a number of so-called stimulative fiscal programs like “Cash for Clunkers” and the “First Time Home Buyers Tax Credit”.

The scam failed — miserably. Even with the transfer of fictional assets to Washington, and replacement of these fictional assets with newly printed fictional money, the accumulation of new debt encouraged by the banking cartel and the Messiah petered out as soon as the programs did.

As we will show next, the second round of quantitative easing by Washington and the banking cartel, dubbed QE2, will not be directed at the impossible goal of encouraging Americans to increase their debt burden when they are already incapable of servicing the debts they currently have. The logic of the current circumstances suggests that pool of potential borrowers must be expanded.

Quantitative easing version 2, we believe, has to result in the replacement of all other currencies by the dollar.

How quantitative easing works — or doesn’t (Part One)

October 29, 2010 1 comment

From the wiki we get a definition of Quantitative Easing:

The term quantitative easing (QE) describes a monetary policy used by some central banks to increase the supply of money by increasing the excess reserves of the banking system. This policy is usually invoked when the normal methods to control the money supply have failed, i.e the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero.

In this excerpt from the wiki, we see that quantitative easing is a method of flooding the economy with money when other, more traditional, methods have already failed. QE is an acknowledgment that the amount of currency in circulation in the economy is probably still contracting, which implies the economy is contracting as well.

QE is undertaken on the assumption that the amount of economic activity can be increased by increasing the amount of currency in circulation. This is because, in times of economic contraction (i.e., a depression), as the economy contracts, money is withdrawn from circulation in order to satisfy (payoff) debts, and no new opportunities for productive investment exists. As money is withdrawn from circulation, this withdrawal is felt as a shortage of credit like the one we are currently experiencing.

This is the rub, however: for reasons we will explain below, QE cannot increase the amount of currency in circulation by itself.

For now, let’s look at how the policy is implemented:

A central bank implements QE by first crediting its own account with money it creates ex nihilo (“out of nothing”).

From this excerpt it is possible to conclude that QE is only possible in an economy with a debased fiat currency. Why? Because, of course, government cannot simply create more gold or other metal money “out of nothing”. Gold requires rather arduous physical exertion in comparison to merely entering the number 1,000,000,000,000 into a computer terminal.

The money created “out of nothing” can itself only be a fiction. It is a fiction of money, since, unlike metal money, it requires no meaningful exertion of human effort, and, hence, has no value.

Most writers — even those who understand that this currency is not really money — still consider it some sort of token representation of money — akin, in some fashion, to the paper money that circulated in the economy prior to the Great Depression. Because of this mistake, their analysis of the economy must be defective. The paper currency that circulated before the Great Depression was token money precisely because it could be exchanged for gold in some fixed proportion. Gold circulated alongside these tokens in the economy — you could walk into a store and use a gold coin to buy groceries.

In short, token money was converted into fictitious money not because it replaced real money in circulation, but because gold was withdrawn by law from circulation as money. This withdrawal removed the token character of the token.

And, why would gold be removed from circulation? Remember our earlier statement: money is withdrawn from circulation leading to a contraction of credit, because economic activity itself is contracting. When the Great Depression hit, gold was pulled from circulation to satisfy debts, and because the amount of profitable investment outlets for which it could be used suddenly shrank. All over the economy, gold fell out of circulation and into lifeless hoards. At the same time, like a game of musical chairs, when the music stopped, everyone without gold suddenly found themselves in dire need of cold hard cash, yet none could be found.

The implication of the above for QE is obvious. During the Great Depression gold did not disappear; it simply reverted to a dead hoard of metal. On the one hand, there was no shortage of money, but an excess of money. On the other hand, however, this money could not actually circulate in the economy since it could serve no productive purpose as capital — just as there were no shortage of workers, or shortage of factories to turn out product, millions of workers and thousands of factories stood idle because no profitable use for them existed as capital.

It is the same for the Federal Reserve’s QE program. It is not enough simply to create a trillion fictitious dollars, having created this fictitious money “out of nothing”, the Federal Reserve now has to get this new fiction to circulate in the economy. This first step is to hand it out to the agents of the Federal Reserve:

It then purchases financial assets, including government bonds, agency debt, mortgage-backed securities and corporate bonds, from banks and other financial institutions in a process referred to as open market operations.

Did you see what just happened? According to the wiki, the Federal Reserve created fictitious money — something absent any value at all — and then used it to purchase some other things: government bonds, agency debt, mortgage-backed securities. These financial instruments, which are in the possession of banks and other financial institutions, are voluntarily sold to the Federal Reserve for a sum of fictional money having no value at all!

It may appear at first that the Federal Reserve is systematically stripping the banks and financial institutions of their assets in return for worthless dancing electrons, but the situation is just the opposite. This is not robbery, folks. There is no coercion involved in the transaction, yet banks and other financial institutions voluntarily hand over their assets to the Federal Reserve in exchange for a fiction that doesn’t exist until the Federal Reserve creates it. Assuming that the CEOs of these financial institutions are not insane, this transaction amounts to an admission that the bonds, debt paper and securities sold have no value — that the face value of the assets are as fictional as the dancing electrons for which they are being exchanged.

There is, of course, this difference between the two fictional objects: at least so far as toxic mortgage-backed securities are concerned: there is no market for them, while currency is currency and can always be spent — especially when the currency in question are dollars.

Also, it should be acknowledged, since the object of the exercise is alleged to be a lowering of interest rates generally, the Federal Reserve will likely be paying more than the original price of the bonds, agency debt, and mortgage-backed securities. In this way, the Fed can push interest rates down still further. (This is because, the higher the price paid for a bond, or like asset, the lower is the interest rate accruing to it.)

So, according to the wiki, the Federal Reserve implements QE by purchasing certain assets from banks for more than the banks paid for them originally — and, this it does in order to push interest rates as low as it can. Rather than stripping banks of their assets with worthless dancing electrons, the Fed actually absorbs worthless assets from them — assets the banks could not sell since there is no market for them — and hands out more currency than the banks initially paid to purchase the assets.

Since, the Federal Reserve is only an oligarchy of private banks, ruling behind the fig leaf of laws which give them “responsibility” (read: control) of the world reserve currency, it is unimaginable that the situation could be otherwise. This much is revealed in the next silly statement by the wiki:

The purchases, by way of account deposits, give banks the excess reserves required for them to create new money, and thus hopefully induce a stimulation of the economy, by the process of deposit multiplication from increased lending in the fractional reserve banking system.

The authors of the wiki entry invite us to believe that the banking cartel, which already has the legal capacity to create currency out of nothing, now needs currency on hand to create this currency out of nothing! In fact, the actual mechanism of currency creation differs drastically from this scenario: Banks create currency simply by creating a balance in your account whenever you borrow — or in the account of the person from whom you purchase something. They do not need to have any excess reserve in place to create this money, since all of this is done at a computer terminal.

Excess reserves, therefore, do not stimulate lending at all. And, the wiki, in this particular explanation, gets us no closer to understanding how QE actually works.

In part two, we will try to get closer to a real explanation.

The Freudian Messiah…

October 28, 2010 Leave a comment

You progressives are doomed…

Here: Obama: “Heckuva Job” Summers

The most disturbing moment of John Stewart’s interview with President Obama was when Obama claimed the soon-to-exit director of the National Economic Council, Larry Summers, had done a “Heckuva Job.” It was a statement both profoundly wrong and politically stupid. On so many levels, it was an awful thing to say just days before the election. It is a moment that has honestly made me question Obama’s judgment and basic intelligence.

No! That is not the awful thing.

The awful thing thing is the absolute servility of progressives to the Democratic Party.

Was there really a deal between Boeing and Saudi Arabia?

October 28, 2010 Leave a comment

Interesting piece of information, but we are unclear on its actual impact:

Gross Domestic Product in the third quarter may be positive solely because of a lucrative defense contract between Boeing and Saudi Arabia.

According to Karl Denninger at Market Ticker, durable goods showed uncharacteristic signs of life solely based on defense related activities:

… the real stunner was the insane ramp in both defense and non-defense aircraft and parts.  Absent that this report have been an abject disaster – and, in point of fact, it was.

Indeed, absent this segment of the economy, durable goods orders actually contracted in the third quarter, per Economic Populist writer Robert Oak:

Durable Goods New Orders Up 3.3% for September 2010

New Orders in Durable Goods increased 3.3% for September 2010. New orders has declined 2 of the past 4 months, with July showing a slight 0.7% increase. New orders in non-defense capital goods increased 8.6%. Core capital goods new orders fell -0.6%. August Durable Goods new orders was also revised up, to -1.0% with August core capital goods new orders revised up to 4.8% from 4.1%.

 

Durable Goods

Aircraft & parts, non-defense, new orders ballooned up +105.0% and defense airplanes also jumped 30.0%. While other analysis seems to blow off aircraft, that’s a $6.6 billion increase in one month of non-defense aircraft & parts new orders. Transportation new orders alone increased +15.7% in September. [our emphasis]  Autos (vehicles & parts) new orders down -0.4%. In the Advance Report on Durable Goods Manufacturers’ Shipments, Inventories, and Orders:

Excluding transportation, new orders decreased 0.8%. Excluding defense, new orders increased 2.9%.

Core capital goods are a leading indicator of future economic growth. It’s all of the stuff used to make other stuff, kind of an future investment in the business meter. Core capital goods excludes defense and all aircraft. New orders are down -0.6%. Shipments are up 0.4%. Two things to note, core capital goods has not recovered to 2007 levels but this month are some not so great numbers, masked by the incredible news on air-o-planes. [our emphasis]

What is odd about the Boeing-Saudi deal is not simply that it drags an important part of the economy across the zero line at a time when all other indicators show it is cratering. As a defense contractor Boeing would probably fall under a little known section of the Securities Exchange Act of 1934 that authorizes the President to direct companies of significance to national security to falsify their books, records and accounts in the interest of national security:

Section 13(b)(3)(A) of the Securities Exchange Act of 1934 provides that “with respect to matters concerning the national security of the United States,” the President or the head of an Executive Branch agency may exempt companies from certain critical legal obligations. These obligations include keeping accurate “books, records, and accounts” and maintaining “a system of internal accounting controls sufficient” to ensure the propriety of financial transactions and the preparation of financial statements in compliance with “generally accepted accounting principles.”

From the Wiki entry, it seems possible that the president could not only prevent Boeing from reporting accurately what it is doing, but could compel Boeing to report things it is not doing, such as producing $60 billion worth of output for a vassal state of the empire.

Simply stated, there is no way to know if GDP as reported in the third quarter — which will be announced just before the mid-terms — will be even close to what is actually taking place in the economy.

Call us paranoid, if you like.

Then read the entry we previously posted by Yves Smith at Naked Capitalism.

Red Pill, Blue Pill…

October 28, 2010 Leave a comment

If there’s one thing on which both left and right agree, it is that the Messiah has lost his halo. Yves Smith of Naked Capitalism rips the O-man as a soon-to-be abject failure. For those disappointed progressives whose idea of health care reform was the now-defunct European social-democratic model of universal care, the revelations soon to be coming in foreclosuregate will amount to taking the red pill on the whole notion of moderate reform within the context of the existing political-economy.

Please, if you just want to cheer the home team into the mid-terms — TAKE THE FUCKING BLUE PILL, NOW! PLEASE!

Obama No Longer Bothering to Lie Credibly: Claims Financial Crisis Cost Less Than S&L Crisis

I’m so offended by the latest Obama canard, that the financial crisis of 2007-2008 cost less than 1% of GDP, that I barely know where to begin. Not only does this Administration lie on a routine basis, it doesn’t even bother to tell credible lies. .And this one came directly from the top, not via minions. It’s not that this misrepresentation is earth-shaking, but that it epitomizes why the Obama Administration is well on its way to being an abject failure.

… if you want a better tally of the true costs of the financial crisis, the Bank of England’s Anthony Haldane comes up with much greater damage, precisely because he also considers the costs citizens know all too well, such as painfully high unemployment and drastic state and local government budget cuts. He estimates the cost of the global financial crisis, when you include the biggest item, output losses, at one to five times global GDP. And remember further, because a lot of bad US assets, like mortgage securities and CDOs, were sold overseas, the US did not bear the full costs of the toxic product we created, again undermining Obama’s phony accounting:

….these losses are multiples of the static costs, lying anywhere between one and five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.

It is clear that banks would not have deep enough pockets to foot this bill. Assuming that a crisis occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of $1.5 trillion per year. The total market capitalisation of the largest global banks is currently only around $1.2 trillion. Fully internalising the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.

Tea Party founder: “Tea Party is a joke”

October 28, 2010 Leave a comment

Vodpod videos no longer available.

Not to be outdone by disappointed progressives, Tea Baggers have awakened to find their movement converted into a corporate Trojan horse.

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Proposed law would name Wikileaks a national security threat

October 27, 2010 Leave a comment

From AntiWar.com:

Senate to Mull Anti-WikiLeaks Law

Saying that it was vital to stop “WikiLeaks from hiding like a coward behind a computer mainframe,” Senator John Ensign (R – NV) announced today that he intends to push forward with legislation that aims to formally criminalize WikiLeaks as well as severely curtailing the ability to release classified documents.

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