Monday, October 10, 2011

Dear Ben,

I woke up thinking how in Japan, the quantity of M1 money is now greater than GDP...

Graph #1

And how, here in the U.S., the quantity of base money is greater than M1...

Graph #2

And wondering if base money in Japan is higher than GDP...

Graph #3, Source: Paul Krugman

According to Krugman, it is not.

Since 1995, the quantity of Japan's base money has doubled. In the U.S since 2008, base money has tripled...

Graph #4, Source: Paul Krugman

Actually, Ben, it looks like you thought you could double the money and be done with it (in 2008) but then you waited and it didn't work, so you tried another 50% in 2009 and waited to see if that worked, and when it didn't you tried another 50% boost in 2011. That's sure how it looks to me.

This is a completely unnatural situation, and dangerous for the dollar no matter what Krugman says. But besides than, Ben, it's not working. Even Krugman agrees with that.

Ben, listen to me. You're doing the wrong thing. You're trying to fix things the wrong way. I'm not one of those people who went into a panic when you started doubling the quantity of money. I'm not. But you tripled the money, and it barely had any effect! You're starting to remind me of Norm Peterson and Cliff Clavin.

There was an episode of Cheers where Dr. Crane brought his rat machine into the bar. You know, where the rat pushes a lever and gets either a treat or a shock, depending which lever he pushes. Norm and Cliff were playing with this machine, trying to get it to give them a treat. But they kept pushing the wrong lever...

It's not working, Ben. You're still worrying about deflation. You're still worrying about recession. You're still worrying about the level of home prices. You're in the same boat you were in three years ago. Your plan isn't working. You're pushing the wrong lever.

I know, buddy, you have to do something. I know. And I think you don't know what else to do. But that's no excuse, Ben. Ignorance is no excuse.


nanute said...

"Dear Art"
My question: What is the correlation between the increase of base money and the velocity of money? Increasing the base money does nothing if it doesn't multiply. As you see in your next post, the M1 Multiplier is below zero. This would imply that the velocity of money is in real terms, negative. The Fed won't come right out and say it but, tripling the base money while paying interest on excess reserves was nothing more than a means to allow the zombie banks to recapitalize at the expense of the overall economy. Either penalize excess reserves, raise inflation by helicopter drop, monetize private debt or watch the carnage continue.

The Arthurian said...

I think that's a really good question.

I think there are several models or descriptions of how velocity works One is simple: the money moves faster. You can feel it, you know. Money moves faster in a bustling city than in a lazy town in the country. Faster at the county fair than at the country store. Faster at the peak of the business cycle than in a recession. And faster in a booming civilization than a dark age.

Still, there are limits to how fast a dollar can move. When people are doing the bills before payday, and mailing out checks on payday, money is being spent just about as fast as it can be spent. Velocity cannot be increased much more, simply by spending faster.

To spend a little faster then, people might borrow money and spend that.

You might think that spending borrowed money wouldn't increase velocity, because the quantity of money must increase more or less in proportion to the volume of spending. That's what I was thinking. But apparently, borrowing money doesn't add to the quantity of money. Or if it does, the money sure disappears quick. At any rate, the quantity of money in circulation is far less than the amount of debt outstanding.

When you borrow a dollar, you get a dollar of money and a dollar of debt. And when you spend the money it goes into circulation, so it ought to count as M1 money. But M1 is way less than total debt. Probably some of the money goes into savings, and some of it goes away in foreign trade. But, wow -- all we have is one dollar out of 27, and back in 2007 it one out of 35. Where did the rest of the money go?

At this time I cannot say.

Of course, now that everybody's deleveraging, destroying money by paying off debt with it, they're not spending that money and so velocity falls even faster than before the crisis.

If the money just disappeared because we paid off debt with it, that would be fine. But if we still have 27 times as much debt as money, where will the money come from to pay off debt???

nanute said...

Thanks for the response. I am thinking more in terms of the multiplier effect and fractional reserve banking. Is it wrong to assume that if I can leverage 10:1 that a 1,000 dollars could generate 100,000 of money velocity? The point being that in current circumstances velocity in these terms, is not happening. Yes, the Fed has increased the supply of money, but it isn't circulating. This is clearly related to your point of how do we pay off the debt hangover. The banks have been given the means to pay off future exposure for overvalued "assets" by being allowed to earn interest on excess reserve deposits. Not only were the financials given large infusions of capital via TARP, they were then permitted to charge the government for the pleasure of taking free money and earning interest on it. Consumers and borrowers on the other hand have not benefited monetarily or economically from this arrangement. I think that some sort of debt forgiveness is in order to restore the economy back to equilibrium. This doesn't square well with those that have been responsible in paying back what has been borrowed. Nevertheless, it will be necessary to either forgive some private debt that cannot be repaid, or the cycle will continue. The government could very easily monetize student loan debt. It is the guarantor of the debt at the end of the day. Getting the banks and bondholders to take a haircut, is another matter completely.

The Arthurian said...

The relation between velocity and the money multiplier is still hazy to me...

"...velocity in these terms, is not happening. Yes, the Fed has increased the supply of money, but it isn't circulating."

Well that's for sure. Hey, Sackerson at Broad Oak has a relevant post: Money velocity, not quantity, caused the boom'n'bust.

In your earlier remarks, I don't get the concept of "monetize private debt". Can you explain or give me an example?

nanute said...

I might be wrong on this, but I think the government could monetize debt by issuing new bonds to pay off existing student loans that it guarantees to "private' lenders. The problem with this example is that government backed student loans cannot be forgiven, even in bankruptcy proceedings. Thinking about this further, if the loans are guaranteed by the Federal government, I guess you could argue it is public debt at the end of the day.

The Arthurian said...

Hi Nute. I'm not challenging you on that "monetize" thing. Just trying to fit it in with what I think I know. I first saw the word used by Milton Friedman, in the context of monetizing the federal debt. For a long time I didn't know what Friedman meant.

Now I think Friedman meant that the Federal Reserve would buy some Treasury securities and put money into the economy in exchange.

I also suppose that whatever the Federal Reserve buys, putting new money into the economy, the stuff bought is "monetized". There's been a lot of that going on, over the past three years.

So I guess if the Federal Reserve bought up student loans, that would be monetizing them.

Oh. You wrote: "government backed student loans cannot be forgiven, even in bankruptcy proceedings."

Wow. That is a law? Sounds to me like a big step down the road to serfdom.

nanute said...

In order to extinguish student loans in bankruptcy you have to be able to prove "undue hardship." This is not an easy task, but technically speaking it is possible to discharge the debt. I stand corrected. Here's a link to an explanation of monetizing debt that I found early this AM, if you are interested.